Spend Visibility is Foundational for EBITDA Improvement
Jake Wojcik shares why private equity firms are relying on implementing operational efficiencies to quickly accelerate savings and maximize profit.
Procurement optimization has become one of the most important EBITDA improvement levers for private equity firms and their operating partners. With investment valuations on the rise, private equity firms are increasingly relying on implementing operational efficiencies to quickly accelerate savings and maximize profits — and focusing in on procurement is becoming the “go-to” strategy. In addition, extended hold times of portfolio companies and lower management fees due to less capital being deployed on a regular basis has led to PE firms to ask their operating partners to do more with less.
PE firms typically have a toolkit of strategies to work with to increase top-line revenue and identify savings opportunities. Operating partners have found that procurement cost optimization is fast, delivering impact in as little as 30–60 days. It has an exceptional leverage effect in that a dollar of procurement-related cost reduction has an equal impact on EBITDA without the added complexity or separation costs associated with headcount reduction. And typically, the opportunity at a portfolio company-level can be determined quickly.
As an example of a PE operating partner point-of-view, if a company’s spend on non-payroll expenses is greater than its EBITDA, then a 1% decrease in spend will increase EBITDA by more than 1%. In most cases, a company’s procurement spend is many times its EBITDA, so a 10% reduction in spend may make a 20% to 40% improvement in EBITDA. There are few performance-improvement levers that offer such a dramatic, immediate impact.
Most companies would need $5 to $20 in net new sales to generate a single dollar in EBITDA impact. And in today’s market where company valuations are greater than 7X–10X EBITDA, a program that nets $5 million in savings can have a $35 million–$50 million valuation impact for a PE firm and its investors.
As PE firms evaluate the right procurement operating model to engage with their investments, one of the biggest challenges a PE operating partner faces when collaborating with individual portfolio companies to optimize procurement is discovering that spend data is surprisingly poor and many of their investments have a limited understanding of their annual expenditures except for their largest areas. As a result, self-reported volume figures are notoriously inaccurate, resulting in a risk of understating volumes and sub-optimizing savings or overstating them and creating a negative relationship with the selected suppliers. Spend visibility is a critical path element, and no portfolio company can make a claim to world-class status or even average performance if it lacks this entry-level capability.
For PE firms’ procurement programs to evolve beyond individual portfolio company optimization and group purchasing programs (GPOs), the requirements for good data become amplified when considering cross-portfolio synergies and the development of private “leveraged” programs where there is a clear and intuitive opportunity to consolidate volumes and negotiate far better pricing. Many private equity firms, however, undervalue the importance spend visibility and its critical role in helping operating partners define their optimal procurement operating strategies, maximize savings and measure spend compliance.
Below is an example of how PE procurement programs can evolve beyond GPOs and individual portfolio company optimization, of which cross-portfolio spend analytics is the foundation for investment collaboration and sourcing synergies:
Regardless of the operating model adopted by PE firms, the benefits of procurement-related cost optimization are obvious in terms of cash flow, EBITDA and competitive advantage. Excellence in procurement is surprisingly elusive and few companies are truly best in class, leaving opportunities for private equity firms to drive improvements and offset some of the negatives of today’s markets. And the journey starts with world-class spend visibility as a foundation to implement and accelerate the procurement strategy for PE-owned portfolio companies.