Introduction
The last decade has seen one of the longest bull-runs in the history of capital markets with no major economic downturn. During this period, the Private Equity market has grown like never before. The PE market has seen unprecedented interest from even the most conservative pension and endowment funds. The fact that private equity and venture capitalists control more companies now than ever is evident when we look at the number of public companies in the US which has more than halved from 1996 (8000) to 2023 (3700). In the PE world, where market forces and comparable company multiples determine the acquisition and exit valuations, the increase in the number of PE firms competing for the finite universe of investment opportunities has led to soaring valuations and high entry multiples.
Private equity investments typically have a holding period of 3-5 years and given that the markets are witnessing an extended period of growth, there is a high probability that companies being transacted currently will face a downturn over their holding period. High entry multiples, uncertain economic climate and decreasing IRR for private equity investments has re-emphasized the focus on maximizing investment value through private equity consulting at portfolio companies.
Impact of an Economic Downturn on Key PE Metrics
Today, more than 65% of PE firms across the globe have employed some form of the operating partner model and 90% of these seek external operational expertise to drive value. In fact, operational expertise has become one of the most sought-after criteria that most LPs look for when scouting for GPs for new investments.
Key Criteria Considered by LPs When Scouting for GPs for New Investments
Procurement and sourcing capabilities is one of the most critical components of any operations strategy. If implemented appropriately in a structured approach, procurement is also one of the quickest operational levers to start delivering value for a portfolio company. Procurement not only generates short-term savings, but it helps create sustainable long-term value which leads to a two-fold impact on exit valuations. Procurement has thus proved to be an effective contributor to Return on Investment (ROI) improvements of PE investments.
Procurement Excellence In Private Equity is Challenging
Implementing best-in-class private equity procurement techniques to achieve quick savings and boost EBIDTA, however, is inherently challenging for private equity firms. Their unique spend profile spread across several portfolio companies operating in multiple industries adds complexities to leveraging cross portfolio collective spend to maximize procurement benefits. Some of the major procurement challenges faced by private equity firms are summarized below.
Procurement Challenges Faced by PE Firms
At different portfolio companies and the central procurement team at the PE firm. The fact that procurement organizations can be at different levels of maturity in portfolio companies is also prohibitive to strategic collaboration
As it is spread across different portfolio companies, potentially operating in separate industries, following inconsistent spend taxonomies and using different ERP, account payables or general ledger systems
At different portfolio companies and the central procurement team at the PE firm. The fact that procurement organizations can be at different levels of maturity in portfolio companies is also prohibitive to strategic collaboration
At different portfolio companies and the central procurement team at the PE firm. The fact that procurement organizations can be at different levels of maturity in portfolio companies is also prohibitive to strategic collaboration
Our Structured Approach For Private Equity Consulting & Procurement Is Focused On Implementing Best Practices
We are experienced in working with PE firms and their portfolio companies to implement proven procurement strategies in a challenging PE environment. Given the complexity of portfolio-wide spend aggregation and other unique challenges faced by the industry, our experience dictates that it is best to design a tailored procurement strategy that would work for that PE firm. The final strategy and extent of aggregation should be based on the specific set of portfolio companies and management structure at the PE firm. We recommend the following steps to private equity firms who are looking to achieve operational excellence and enhance valuations through procurement savings.
Spend Analysis
The first step towards unlocking procurement benefits is to get comprehensive visibility of the spend. Typically, the quality of spend data at portfolio companies is below par, spread across multiple systems and is unsatisfactorily categorized. A spend analysis program can help harmonize categories and taxonomies across portfolio companies and allow the management to get a holistic view of the aggregate spend. Subsequently this data can be used to derive actionable business insights, uncover hidden savings opportunities and direct the overall procurement strategy for the PE firm.
Opportunity Assessment and Implementation for Portfolio companies
The operational excellence team led by the operating partner should work with individual portfolio companies to identify savings opportunities through spend analysis, contract analysis and stakeholder interviews. Given that time is critical for all private equity investments, we recommend an expedited approach for opportunity identification and execution. A quick opportunity assessment followed by a rapid sourcing program to renegotiate high value contracts and consolidate spend to key suppliers can enable quick bottom-line savings. Additionally, to capture incremental value, market bidding (RFP) and demand management projects for pertinent categories should be launched simultaneously to get competitive rates, optimize consumption and gain additional leverage on incumbent suppliers.
Portfolio-wide Spend Aggregation and Formulation of Procurement Strategy
The operating partner and their team should collaborate with the leadership of all portfolio companies to identify spend areas which can be sourced collectively. Typically, categories such as travel, office supplies, IT telecom, car rental etc. are most easily aggregated. The aggregated spend can then be sourced by implementing the most suitable strategies, some of which are highlighted below.
Private Equity Sourcing Strategies
Renegotiate pricing with incumbent vendors based on increased leverage from aggregated spend
Harmonize pricing and other terms using a ‘best of breed’ approach across common vendors
Consolidated sourcing exercise (RFP) for indirect spend categories by leveraging aggregate spend as much as possible
Suppliers can sometimes be reluctant to work in a cross-portfolio environment due to concerns around ownership stakes and the extent of the private equity firm’s influence on company management. We are experienced in drafting and negotiating equitable terms in the contract to assure fair deal for suppliers even as the private equity firm continues to add new investments to the portfolio as well as make exits.
We are also well versed with the complexities of the private equity universe and has developed a comprehensive approach to private equity procurement which can be fine-tuned to the economic conditions and specific companies to deliver savings in an accelerated timeline. A $400M PE-owned insurance company achieved 7% savings on their third party spend in just 6 months with us.
Conclusion
With the changing economic climate and the overall shift towards private equity in the capital markets, private equity firms must deploy all available tools and resources to maintain and increase the IRR of their investments. While private equity stakeholders are increasingly focused on capturing value through operating improvements and procurement excellence, they must analyze all options and constraints to develop a suitable strategy which can drive results quickly. In our experience, external expertise to guide operations & procurement strategy is critical to ensure timely success. As private equity stakeholders gear up to provide better returns in the ever so challenging times, a disciplined approach will go a long way in realizing its goal.
