Private equity and unlocking third party spend

How can private equity portfolio companies unlock value in indirect third party spend

Mike Lander Blog, Private Equity

It is a common practice amongst Private Equity(PE) owned companies to tap into an Aggregator purchasing organisation that could leverage the bulk buying power of the entire portfolio owned by the PE owner.

In the cases where portfolio companies are small to medium in size, it is often the case that they do not have indirect procurement departments. As the PE firms have arrangements with Aggregator companies, portfolio CFOs often think that the majority of the value on the table has been captured and thus the marginal returns on investing in an Indirect procurement team is minimal- given that they have commercially minded operations teams and that they have strong control systems that maintains tight and disciplined control over spend.

Having delivered many cost reduction engagements across PE owned companies in a number of sectors, we can confidently say that this does not reflect the total picture of how to create enhanced, sustainable, EBITDA improvement. There’s often lot of latent value trapped in the third party spend of these companies that can be accessed with focused, experienced procurement expertise on either a project or managed service basis.

Firstly, many indirect categories are not suited for leveraging economies of scale in bulk buying including marketing spend on advertising andspend on creative agencies. Furthermore, Aggregators tend to avoid getting into many important questions that need to be addressed when looking at sourcing activity from a strategic perspective. For example, questions such as “Is the ordering frequency optimal” or “Is there an opportunity to look at a different specification” or “Is there an opportunity to improve the demand generation process”. Our experience is that there are a significant list of demand and supply side levers that aren’t addressed by the aggregator companies alone. Given the lean structures of PE investment assets, the operations team are often stretched and rely on their supply base to provide innovation, benchmarking and market knowledge. This plus the fact that they are often not highly experienced category buyers means that value is often left on the table.

Aggregator companies on the other hand club the volume of the entire group and take it to the market for getting a “potentially” better price because of aggregated volumes. We say potentially because it is typically observed that the framework agreements built by the Aggregators tend to avoid strong terms like volume commitment or spend exclusivity (as there are too many stakeholders across a portfolio and thus it’s difficult to tread this territory). This often leaves a big chunk of value on the table as suppliers would not go the extra mile in offering best price in the absence of these terms.

Furthermore, in the absence of a procurement team, contract non-compliance is typically high, i.e. although operations team would have started a Supplier relationship on the basis of an Aggregator contract, over time, they would modify their requirements and suppliers will have a free hand in charging sub-optimal prices for such services. As Aggregators don’t look into the contract compliance, no one in the company notices the value leakage across the organisation.

To conclude, although leveraging Aggregator contracts is a good tool in Company’s kit-bag to improve their EBITDA, many CFOs have realised that it is just “a” tool and that there’s more to be done to achieve the best commercial benefits. Unlocking the hidden value in the indirect procurement is a huge undertaking, requiring specialized skills and insights. CFOs have a choice to either build this capability internally or partner with specialists. Many of our clients have typically started with letting us run a programme that shows the value to begin with and then build on from there.