Despite several years of unexpected disruption, the global supply chain is returning to a normative state, allaying many companies’ concerns regarding logistics and procurement. However, as M&A activity picks up, mitigating risk remains a primary challenge for companies considering acquisitions that may have a material impact on their supply chain. Broadly, these can be categorized into three areas of focus.
1. Procurement Contracts and Processes
First on the list of supply chain diligence priorities is a thorough assessment of the target’s contracts, master services agreements, and overall vendor processes. Gaining a clear understanding of the target’s contractual obligations, vendor onboarding/management process, and potential stranded costs is critical to evaluating the organizational risk – and cost – of the transaction.
| Task | Actions |
|---|---|
| Review of Item/Vendor Masters | Depending on the size and maturity of the target, their contracting processes may not have a level of rigor commensurate with the buyer’s procedures. Careful review of the vendor master (procurement records, inventory data, etc.) and any standard contract term sheets is necessary to gain a full understanding of the target’s operational posture. |
| Evergreen Contract Review | Frequently, companies with less mature procurement functions may allow vendors more favorable contract terms in the form of “evergreen” contracts that extend indefinitely unless terminated by either party. It’s critical to identify, analyze and, if necessary, terminate these contracts to ensure there are no unforeseen pitfalls that may impair deal value. |
| Master Services Agreement Review | As with the contract review process, a thorough breakdown of Master Services Agreements is a necessity to gain a clear picture of the target company’s standard vendor terms. While these may vary somewhat (length of relationship, criticality of that supplier, volume), the objective is to uncover vulnerabilities in pricing or contract length. |
| Contract Novation | Understanding contract novation is a critical concern for any transaction, but vendor contracts are a particularly important area to consider. Notably, awareness of any change in ownership provisions is paramount, as it can negatively affect vendor/customer terms and dilute deal value. |
| Stranded Costs | On the buy-side, care must be taken to evaluate potential stranded costs. These might include extraneous facility leases, software licenses, or shared services support that will not be required after the target company/business unit is fully integrated into the buyer’s company. Additionally, in the case of buying a carve-out entity, care must be taken to evaluate costs previously provided by the parent company. Depending on the willingness of the seller, some of these costs may be carved out of the sale or charged back. More typically, stranded costs are mitigated by establishing robust and thorough Transition Services Agreement (TSA) schedules to lay out the scope and duration of ongoing support and appropriately allocate costs. |
2. Supply Chain Systems and Financials
Once the relative risk and cost of the supplier processes are understood, the natural next step is an evaluation of the target’s business systems and data. Depending on the degree of entanglement, there may be substantial work required to convert or stand up the target’s business systems, which may include integrating with or migrating to the buyer’s systems, devising an adequate structure for management reporting, and agreeing upon shared services support.
| Task | Actions |
|---|---|
| MRP/ERP Adjustments | Business systems once fit for purpose may no longer be adequate for future growth, particularly if the eventual combined entity will materially increase the size and scale of the company. Buyers must account for the cost of upgrading those systems or integrating the acquired company into their own, which may also include significant reconfiguration of the target’s procurement ERP/MRP modules. |
| Data Integration | If, in the above example, the buyer opts to retain legacy systems, building data integration and warehousing is a critical step to enable reporting for the combined entity and day-to-day operations. Additionally, there are considerations regarding controls and separation of duties assignments between the legacy systems and those of the buyer. Finally, changes to the target’s procurement philosophy – for example, rationalizing the supplier base to leverage economies of scale – must be taken into account prior to making wholesale changes to its data and systems architecture. |
3. Supplier Strategy
Finally, a comprehensive supply chain diligence process includes an in-depth appraisal of the target company’s supplier strategy and structure. This includes evaluating their physical footprint and geographic spread, reviewing their overall sourcing philosophy, comparing the buyer and target value chains for overlap, and seeking out opportunities to leverage economies of scale.
| Task | Actions |
|---|---|
| Value Chain Risk Assessment | Although this goes beyond the typical scope of financial diligence, conducting a risk assessment of the target’s supply chain posture can solidify deal value and uncover risks for mitigation. This includes heatmapping the target’s physical/vendor footprint, evaluating transportation mode risk, reviewing inventory velocity, and assessing both the target and vendor’s quality programs. |
| Sourcing Strategy | While not all companies have global supply chains, it’s important to understand the target’s sourcing philosophy. This includes evaluation of their low-cost (or strategic) sourcing programs, vendor volume management, and the potential cost and operational headache of re-shoring or otherwise adjusting the vendor base to reduce perceived risk. |
| Supplier Rationalization | In the event of material similarity between the target and buyer’s supply chains, the diligence process should seek to evaluate opportunities for rationalization, reducing duplicates, and taking advantage of favorable contract terms. |
Maximizing M&A Value
Companies that expand their diligence efforts beyond finance and legal invest in the future success of the transaction. Highlighting material risks and operational obstacles in the early stages of the deal cycle provides sharper context for the valuation and allows more runway for mitigation of factors that may have otherwise impaired deal value.
CrossCountry Consulting’s integrated business transformation and transactions advisory solutions help companies identify, process, and resolve operational and supply chain risks for optimized long-term positioning and valuation. For industry-leading transactions support, contact CrossCountry Consulting.