Linking business processes with financial outcomes should supplement merger and acquisition due diligence.
When a company is growing either by merger or acquisition (M&A), looking over the profit and loss (P&L) statement and balance sheet is simply not enough to make a "go" or "no go" decision. With M&As on the rise again, it may be prudent to examine the reasons that sound strategic on the surface, yet deep down may not adequately represent the new valuation of the combined business.
For example, one common strategy is leveraging another company's brand. Executives may proudly tell their shareholders, "We plan to integrate this new company into our own brand to move into a higher-end business to gain greater market share. And while we're at it, we'll leverage our sourcing and buy everything from the same vendors." Yet, if the acquired company's model is to outsource manufacturing, does it make sense to destroy its vendor base and pull it all into the acquirer's own production facilities?
Another M&A theme is retaining both sales organizations because, after all, any sale is a considered a good sale, right? Yet, what if the two organizations have different value propositions? If one is geared toward on-time delivery and the other to low price, mixed messages could be sent; the organization should consider how customers will be impacted by the resulting change.
Linking Business Processes
Mergers and acquisitions traditionally have had a high failure rate. The management consulting firm McKinsey & Co. reports that 61 percent fail to earn cost of capital or better on funds invested. A British source indicates that the failure rate of most mergers and acquisitions lies somewhere between 40 to 80 percent.
To offset history, it's essential for senior managers to go beyond traditional financial metrics and recognize the links ? the interrelationships ? between business processes and financial outcomes. When similar processes and procedures within each of the organizations' supply and demand chains are uncovered, management can more clearly see how the two organizations complement or conflict each other.
But first, it's essential to develop an understanding of what needs to change and what should remain the same if the acquisition takes place. This is achieved by analyzing and documenting the internal and external material flows of both organizations, uncovering disconnects in the flow of physical material, and identifying the processes in place throughout the companies' supply and demand chains.
Consider applying the Supply Chain Reference (SCOR) model, a process reference methodology maintained by the Supply-Chain Council that allows companies to examine and measure their supply chain processes, determine where weak links exist and identify how to make improvements. A corresponding methodology for the demand chain is the Demand Chain Reference (DCOR) model, which defines the demand chain as a set of integrated processes that address customer requirements as well as revenue channels.
Using these models during due diligence provide a holistic view of a company's organizational structure and processes to determine the health of P&L and balance sheet results.
Common Language and Best Practices
Terminology is important to aligning how each organization accomplishes each step in its processes. These models, when used together, can help two merging organizations to establish a common language for comparing metrics.
From a supply side, both organizations can define how they plan, source, make, deliver and return. For example, "deliver" may mean transportation only to one company while another company may also include order entry.
From a demand side, both organizations can define how they plan, create, sell, market and service. For example, "service" to one company may mean repairing a faulty product through field management, while another company also may include call center management with repair functions in its definition of service.
While going through a long M&A process, organizations tend to forget that revenue boost and/or market share is the ultimate objective, which is why a focus on taking good care of customers is important during the transition. The DCOR methodology identifies best practices associated with customer management/customer service and the appropriate performance metrics to ensure both organizations are meeting the expectations of the customer.
Benchmarking
To gain an accurate view of strengths and weaknesses via financial and operational metrics, both models provide a scorecard for benchmarking performance metrics that ultimately get rolled up into the P&L. Digging deeper can help managers understand if the financial metrics are optimized. They can quickly evaluate the target company and preview what the integrated company will look like.
For example, how can executives look at the inventory on a balance sheet and know if inventory levels are good, too much or not enough? First, they would need to know, for example, if a manufacturer is make-to-stock or make-to-order from a supply chain side. A classic make-to-stock company is making product on a forecast and holding that inventory either in a warehouse or distribution facility, whereas a classic make-to-order company waits for the customer order to come in before production starts.
The benchmarks for these two manufacturers are different in terms of raw material versus finished goods on hand. Ultimately, these supply chain metrics are linked back to demand chain metrics, such as product development timing, turnover of old products and how good that inventory is going to be over a long period of time.
Some demand chain metrics to consider in this example:
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Supply and demand chain metrics can be very helpful in determining acquiree value and purchase offer. Deeper-level metrics in either value chain can establish rational and reasonable synergy around a proposed merger. For example, benchmarks can show that a company is 20 percentage points off in inventory. If the executives see a possible reduction, it may be worth millions of revenues over the short term and provide more confidence in the price that the acquiring company is willing to pay.
Customer share and market share are two critical measurements identified within the DCOR model:
Rather than reading an aggregated P&L of a target company to acquire or merge, the key is to dig deeper while conducting due diligence from a supply and demand chain perspective. Only then will management have a clearer understanding of how the two organizations complement or conflict with each other.
When a company is growing either by merger or acquisition (M&A), looking over the profit and loss (P&L) statement and balance sheet is simply not enough to make a "go" or "no go" decision. With M&As on the rise again, it may be prudent to examine the reasons that sound strategic on the surface, yet deep down may not adequately represent the new valuation of the combined business.
For example, one common strategy is leveraging another company's brand. Executives may proudly tell their shareholders, "We plan to integrate this new company into our own brand to move into a higher-end business to gain greater market share. And while we're at it, we'll leverage our sourcing and buy everything from the same vendors." Yet, if the acquired company's model is to outsource manufacturing, does it make sense to destroy its vendor base and pull it all into the acquirer's own production facilities?
Another M&A theme is retaining both sales organizations because, after all, any sale is a considered a good sale, right? Yet, what if the two organizations have different value propositions? If one is geared toward on-time delivery and the other to low price, mixed messages could be sent; the organization should consider how customers will be impacted by the resulting change.
Linking Business Processes
Mergers and acquisitions traditionally have had a high failure rate. The management consulting firm McKinsey & Co. reports that 61 percent fail to earn cost of capital or better on funds invested. A British source indicates that the failure rate of most mergers and acquisitions lies somewhere between 40 to 80 percent.
To offset history, it's essential for senior managers to go beyond traditional financial metrics and recognize the links ? the interrelationships ? between business processes and financial outcomes. When similar processes and procedures within each of the organizations' supply and demand chains are uncovered, management can more clearly see how the two organizations complement or conflict each other.
But first, it's essential to develop an understanding of what needs to change and what should remain the same if the acquisition takes place. This is achieved by analyzing and documenting the internal and external material flows of both organizations, uncovering disconnects in the flow of physical material, and identifying the processes in place throughout the companies' supply and demand chains.
Consider applying the Supply Chain Reference (SCOR) model, a process reference methodology maintained by the Supply-Chain Council that allows companies to examine and measure their supply chain processes, determine where weak links exist and identify how to make improvements. A corresponding methodology for the demand chain is the Demand Chain Reference (DCOR) model, which defines the demand chain as a set of integrated processes that address customer requirements as well as revenue channels.
Using these models during due diligence provide a holistic view of a company's organizational structure and processes to determine the health of P&L and balance sheet results.
Common Language and Best Practices
Terminology is important to aligning how each organization accomplishes each step in its processes. These models, when used together, can help two merging organizations to establish a common language for comparing metrics.
From a supply side, both organizations can define how they plan, source, make, deliver and return. For example, "deliver" may mean transportation only to one company while another company may also include order entry.
From a demand side, both organizations can define how they plan, create, sell, market and service. For example, "service" to one company may mean repairing a faulty product through field management, while another company also may include call center management with repair functions in its definition of service.
While going through a long M&A process, organizations tend to forget that revenue boost and/or market share is the ultimate objective, which is why a focus on taking good care of customers is important during the transition. The DCOR methodology identifies best practices associated with customer management/customer service and the appropriate performance metrics to ensure both organizations are meeting the expectations of the customer.
Benchmarking
To gain an accurate view of strengths and weaknesses via financial and operational metrics, both models provide a scorecard for benchmarking performance metrics that ultimately get rolled up into the P&L. Digging deeper can help managers understand if the financial metrics are optimized. They can quickly evaluate the target company and preview what the integrated company will look like.
For example, how can executives look at the inventory on a balance sheet and know if inventory levels are good, too much or not enough? First, they would need to know, for example, if a manufacturer is make-to-stock or make-to-order from a supply chain side. A classic make-to-stock company is making product on a forecast and holding that inventory either in a warehouse or distribution facility, whereas a classic make-to-order company waits for the customer order to come in before production starts.
The benchmarks for these two manufacturers are different in terms of raw material versus finished goods on hand. Ultimately, these supply chain metrics are linked back to demand chain metrics, such as product development timing, turnover of old products and how good that inventory is going to be over a long period of time.
Some demand chain metrics to consider in this example:
- New product revenue: The percentage of revenue generated from products and services introduced during the past two to three years. This metric is used to determine how much an organization is spending on "new" innovations. It can often assist an outsider in determining the viability of an organization.
- On-time launch: Product launches that meet or beat the target launch date. This metric assists organizations in determining the effectiveness of a company's ability to get products to market on time. This is not only important to customers but also stockholders. If a deadline or launch is missed, it definitely means a loss in revenue ? sometimes a large revenue loss if a competitor beats the company to market.
- Repeat business ratio: The percentage of revenue from existing clients. This is a critical metric for inferring customer loyalty and satisfaction. In addition, repeat business tends to be more profitable than new business because the costs of marketing, sales and services delivery to well-known customers are less.
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Supply and demand chain metrics can be very helpful in determining acquiree value and purchase offer. Deeper-level metrics in either value chain can establish rational and reasonable synergy around a proposed merger. For example, benchmarks can show that a company is 20 percentage points off in inventory. If the executives see a possible reduction, it may be worth millions of revenues over the short term and provide more confidence in the price that the acquiring company is willing to pay.
Customer share and market share are two critical measurements identified within the DCOR model:
- Market share is defined as the percent of a given market sold to or owned by a company out of the whole as a result of its success in marketing effectiveness, product characteristics, pricing, cost, delivery time, quality and many other factors. Market share is affected by the type of industry and number of competitors, and can indicate the stage of a product's life cycle (introduction, growth, maturity, decline).
- Customer share is defined as a company's sales of a given product or set of products to a given set of customers, expressed as a percentage of total sales of all such products to customers. When looking to acquire or merge, an organization needs to review the product lines of the corresponding company to identify if the products are similar/competitive and can assist in growing market share, or if the products are in addition to what the organization offers today, which can assist in growing customer share.
Rather than reading an aggregated P&L of a target company to acquire or merge, the key is to dig deeper while conducting due diligence from a supply and demand chain perspective. Only then will management have a clearer understanding of how the two organizations complement or conflict with each other.
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