Procura: Procurement best practice goes from cost cutting to value creation

PE firms are taking an increasingly sophisticated approach to procurement in recognition of its value-creation capabilities, say Procura Consulting’s Richard McIntosh, Brendan McVeigh and Anna Nuttall.

This article is sponsored by Procura Consulting.

Why is procurement excellence such an important value-creation lever, and how has its contribution changed over the past decade?

Richard McIntosh

Richard McIntosh: Procurement excellence is one of the key levers for value creation in any organisation, in terms of both profitability and valuation.

On profitability, any organisation’s external spend on goods and services makes up a significant proportion of its costs. In a retailer that can be as much as 80 percent, in manufacturing as high as 70 percent, and even in services firms like banks or insurance companies it can be up to 40 percent of costs. If you reduce that cost, every pound, dollar or euro that you save directly increases EBITDA. If you were trying to get the same profit impact by increasing sales, you would need to achieve radical change.

On valuation, there is a direct correlation between procurement capability and competitive advantage, so developing a high-performance procurement function improves the valuation multiple.

A decade ago, many private equity firms recognised this, focusing on procurement as a lever to drive cost reduction. Now they have realised that a far more sophisticated approach also drives value creation. That has meant looking at all categories of spend, rather than just the easy wins, working more strategically on cost drivers and developing procurement capabilities that embrace data and digitisation.

Brendan McVeigh: The conversation has gone from ruthlessly slashing costs to taking a more considered and sustainable approach, considering factors such as risk in the supply chain, which has been a significant issue in the past year. Private equity firms now recognise the value of managing that risk and managing their contracts with suppliers more effectively, as well as driving savings to the bottom line.

What should private equity firms consider from a procurement perspective at the diligence phase of a deal?

RM: Historically, procurement, suppliers and the entire supply chain was not looked at during due diligence, but firms have realised they need to really consider this pre-deal. That means looking at spend and the opportunities to improve that; risk, where issues in the supply chain have really come into focus during covid-19; and the procurement capability of the target.

We have worked with private equity firms acquiring companies based on a growth thesis, where they are planning a radical scale-up but they have not considered the ability of the suppliers to ramp up. They may have a high dependency on a single supplier or encounter issues with stock. That is a real focus now.

Investors want to understand how good the target company’s procurement function is, particularly where there is a carve-out and questions over who is going to get what and what needs to be built.

These issues are particularly prevalent in manufacturing and retail, but they apply cross-sector. For example, we have worked with a global technology development company to deliver a procurement cost reduction programme and then put in place a chief procurement officer to build its own capability.

BM: Synergies and cost benefits are often part of the investment thesis, and historically there was no work done pre-acquisition to check those synergies existed and were tangible. Now firms are spending time up-front figuring out what is achievable and what existing supply contracts look like.

Once an acquisition is made, what might procurement transformation look like in practice?

Brendan McVeigh

BM: It varies from portfolio company to portfolio company. The global technology business Richard mentioned had been rapidly growing its top line but had not looked at the cost base. So, the challenge was laying the foundations of a procurement function by seeing what savings could be made and making the case for procurement.

That is very different from a more mature organisation, such as a big hospital group that we work with. The group had an established business with a procurement function in place, but it was struggling with profitability. Procurement needed to be reinvigorated, giving the team the tools and techniques to continue to drive benefits. The group had been in a private equity portfolio for some time and the fund wanted to turn the investment around, so the focus was very much on the bottom line.

Although the output is different, the approach is broadly the same in most cases. There are two levers, the first of which is savings delivery, based on negotiating with suppliers, sourcing new suppliers, revisiting prices and optimising the supply base. The work starts with an opportunity assessment, understanding the spend profile, categorising spend and then devising strategies to drive savings.

The second lever is procurement improvement, which can be establishing a function or enhancing and enabling an existing function by giving it the right tools to drive change. There are also ways to recover cash and improve working capital through contract recovery audits, making sure you have not overpaid suppliers and that suppliers have been meeting their terms, for example.

Anna Nuttall

Anna Nuttall: When it comes to procurement capability improvement, it is a similar process to the savings work we do. We start with a function capability assessment which looks at eight key procurement enablers, such as the procurement strategy, the core processes such as sourcing, supplier and contract management, the skills in the team, the tools they use and the way the procurement operating model is set up.

The output is then tailored to the organisation, where much depends on the maturity of the existing function. We have worked with companies that have no function at all, where we can step in and plug the gap, and organisations with mature functions that need support and direction to improve.

The private equity timeline is typically quite short, so the approach must be pragmatic and drive improvements quickly. Savings are, and always will be, important but achieving a sustainable transformation of the function is growing in significance.

How is digitisation being used to enhance procurement practices?

RM: Digitisation has been a big journey for procurement, which for many years was a laggard of a function. Even now, procurement processes can be very paper-based or non-existent, often done informally by other business functions.

The digitisation wave has seen a shift away from big enterprise resource planning implementations, which would include procurement. In the last couple of years, things have changed completely and there are now lots of new cloud-based software-as-a-service providers offering specific solutions like spend analysis, contract management and supplier performance measurement. There are also many interesting sector-specific and category-specific marketplaces. Companies can access all these solutions and join them up to make a bespoke system, which is a game changer for procurement.

BM: The best-in-breed digital solutions suit private equity-sized businesses up to around £1 billion in enterprise value. When you get into big blue-chip companies, procurement is still in the world of Oracle and SAP, but in the private equity space the tools are nimble, agile and easy to implement. We are helping clients to identify the art of the possible, see what is available, build a business case and then, critically, embed the right tools and make sure they are fully utilised.

AN: We are working with a US biomedical company to help it understand what solutions are out in the market. We have worked with the company to understand its supply base and the risks within that. It does not currently have any digital tools other than an ERP system, so we have proposed a vendor management and contract management tool. There are solutions out there that are quick to implement.

How is procurement excellence evolving in private equity, and what do you see as the next big themes?

RM: The main theme we see is much more sophistication, with a move from procurement being all about cost-cutting to it being key to value creation. There is a new procurement excellence focus, and that plays into digitisation and sustainability, both of which are evolving.

The next big development that is worth highlighting is cross-portfolio procurement, where private equity firms are realising the value of a portfolio approach and the potential for horizontal leverage. Increasingly, firms are looking at the opportunities for portfolio companies to supply each other, collaborate on sourcing, co-ordinate supplier activity, as well as achieve economies of scale through procurement, all of which are uncovered through good spend data analytics. Some of the challenges during the pandemic served to highlight the opportunities on offer from looking across the portfolio, and we expect to see more of that going forward.

What can companies do to move towards sustainable procurement?

RM: We are already seeing ESG becoming a core part of operational excellence, moving out of marketing function ownership and embedding into operations. Organisations are realising that their external spend and their supply chain is one of the biggest levers, as well as risks, for sustainability. There are three pillars – people, planet and profit – and there does not have to be a compromise on one to enhance another.

There is no silver bullet on this; it is about putting in place the policies, strategies and enablers to drive supplier evolution and manage risk. That means building ESG into terms and conditions, tenders, supplier performance measurement and making sure it is embedded across the board.

BM: If you wanted to prioritise sustainability in your supply chain in the past, you had to pay a premium, and only a small number of businesses were prepared to do that. Now, supply chains can demonstrate they can bring sustainability to the table without a cost to the business, so it becomes a no-brainer. Still, there are companies struggling to understand what this all means, what they should be measuring and what they should be asking suppliers, and we see a huge skills gap in procurement in that regard.

Richard McIntosh is a managing partner, Brendan McVeigh is a partner and Anna Nuttall is a senior manager at procurement specialist Procura Consulting