The New Deals

As an economic recovery dawns, executives are starting to see how the downturn has reshaped their businesses. In the drive to reduce both costs and risks, many companies have forged partnerships aimed at improving efficiency or pooling resources.

In a survey by CFO Research Services in March 2011 and sponsored by Ariba, nearly 80% of respondents said their company’s external relationships with suppliers, customers, and business allies will be “very important” to their ability to thrive in the recovery. In a separate question, nearly 60% of respondents said their company is much more or somewhat more likely to pursue strategic partnerships as a result of the economic downturn.

There have been many surveys showing that CFOs believe suppliers are important and yet procurement professionals often find the relationship with their finance colleagues challenging. The question I want to ask is simple: has anything changed to make this relationship easier and more productive for both parties?

Before the recession, businesses reduced costs and increased efficiency by outsourced, off-shored and unloaded non-core functions. In areas like warehousing and delivery, supplier performance was optimised by deploying new technology. These activities were spurred on by economic events like exchange rate variations and rising commodity prices. The recession, however, has been far more severe than any of these other recent economic events and businesses have responded by developing survival tactics to cut costs more dramatically and improve liquidity. Nowadays, managing an efficient supply chain requires executives to probe beneath the surface. Transactional efficiencies may create some direct savings but they do not deliver growth per se. However, the savings that result from maintaining a healthy cost position and managing working capital well can make new investment possible. By shortening its cash conversion cycle, for instance, a business can generate sufficient free cash flow to support an acquisition or joint venture without raising capital externally. Such a self funding strategy often serves as the most cost-effective way to finance growth.

CHC has helped Veolia Water successfully integrate 6 businesses acquired from United Utilities. Efficiencies driven from other parts of the business enabled the acquisition to be self funded. Two of these businesses are joint ventures where Veolia Water has either a majority holding or an equal holding with another company. These joint ventures supply services to other water companies to help them carry out expensive and risky capital projects such as the £300m treatment works for Brighton or undertake non-core functions such as the maintenance of exiting assets.

CHC has also been helping Veolia Water with a start up. Veolia Water recently won a contract with two partners to provide water meter reading services for Thames Water. The newly formed company, Vennsys, has a 10 year contract worth £300m. CHC has been supporting the start-up through procuring HR services such as recruitment and pay roll.

I think the recession has changed the way businesses operate. The survival tactics developed during the recession will continue to be deployed through out the recovery. Many of the most obvious opportunities related to non-core functions have delivered significant efficiencies and increased liquidity. These have helped businesses become more competitive and in some instances, have been used to fuel growth. As the economic recovery takes hold, businesses will be seeking more growth and looking to suppliers to help them.

Two speed recovery

It was encouraging to hear that M&A activity continues to grow. Figures reported this week show that activity in US jumped by 84% and Europe by 27% compared to the same period in 2010. The news of the mega deal between AT&T and T-Mobile demonstrates that some sectors of the global economy are growing in confidence.
Unfortunately UK manufacturing is not one of those sectors. It grew at its slowest pace for five months according to a survey reported today. The Markit/CIPS purchasing managers’ index fell to 57.1 last month, down from a revised 60.9 in February. The survey also found that UK manufacturers increased prices to offset rising raw material costs and slowing consumer demand. This supports my earlier conclusion (Will the Budget affect Procurement?) that procurement professionals can expect to be asked by suppliers for price increases.
“The mini-boom in UK manufacturing ran out of steam during March as faltering domestic consumer confidence, inflationary pressure and supply chain disruption combined to slow down expansion,” said David Noble, chief executive of CIPS.

Will the Budget affect procurement?

Despite the Chancellor calling it a budget for growth, the Office for Budget Responsibility (OBR) begged to differ. The Financial Times reported that “Osborne sticks with Plan A” to cut public sector borrowing and fuel private sector growth. The effect will be no nett increase in growth.

After nearly a decade of lobbying, business got most of the changes to the corporate tax regime that it was seeking. Most significantly, corporation tax will fall from 28 per cent to 26 per cent next month and to 23 per cent by 2014-15. The change means that the UK will have the lowest levels of corporation tax in the G7, assuming the other nations do not follow the Chancellor’s lead. This will attract multinationals to do more business here and create more competition in key sectors.

The banking and oil industry reacted predictably to the increase in the bank levy and the tax on North Sea oil and gas. I believe that threats by the banking industry to move overseas and the oil industry to slow investment lack credibility. One only has to look at the profit announcements in recent months to realise that Britain will remain a good place to do business for some time. This will not stop these industries from trying to pass on these tax rises to their customers as higher prices.

The significant news for procurement came not from the Chancellor but from the Office for National Statistics (ONS) and the OBR. The increase in inflation (CPI) from 4.0% in January to 4.4% in February and the forecast for further increases will give suppliers more reason to ask for price rises. Lower growth and higher unemployment will mean that the pressure on prices cannot be offset by higher volumes. We don’t have to accept these requests but its becoming increasingly difficult.

Japan supply chain risk reverberates globally

As the crisis in Japan deepens by the day our immediate thoughts are with those people affected by the tsunami and the nuclear plant at Fukushima Daiichi.  Japanese police say 6,405 people are known to have died and around 10,200 others are missing. Relief workers bowed their heads as a show of respect for the dead at 1446 local time (0546GMT today), seven days after the quake.

Gillian Tett of the Financial Times (FT) writes an interesting article (Japan supply chain risk reverberates globally, 15 March 2011) highlighting the impact of the crisis on the world’s manufacturing supply chains, most notably in the auto and electronics sectors. Honda, Japan’s second-largest carmaker, said on Monday that it was halting domestic production for a week and that damage to its suppliers’ plants might disrupt its UK production. Toyota, Nissan and Mitsubishi Motors  also extended shutdowns of their plants in order to assess and deal with damage from the quake. Japan not only has some of the world’s leading OEM electronics companies, such as Sony, NEC and Hitachi, they also have a high number of first tier electronics suppliers. Japan produces about 30 per cent of the world’s flash memory (used in electronic cameras and smartphones) and around 15 per cent of the D-Ram memory (used in PCs). Further analysis in the FT (Global industries consider their options, 17 March 2011) highlighted one particular material used to make the substrates that connect chips to printed circuit boards used in handsets. Approximately 90% of the world supply of bismaleimide-triazine (BT) resin is made in Japan. Mitsubishi Gas Chemicals (MGC) makes about half of Japans output and closed its 2 plants on Friday.

Various analysts have commented on the crisis although opinions about its impact vary greatly. I think the most balance view comes from Société Générale, the French bank, commenting on the impact on China. Société Générale said there would be “noticeable short-term disruption” but that the impact was unlikely to be “lasting or devastating” since in many cases back up suppliers from other countries, such as Taiwan or South Korean, could be found. 

The effects of the crisis are being felt in the financial markets; the Nikkei 225 slumped amid panic selling although this morning it has bounced back following agreement to intervene in the currency.

Most purchasers are aware of the risks associated with their more complex supply chains. For some purchasers this crisis will put additional demands on their skills to evaluate the impact and to find alternative sources of supply. What is clear, however, is that the crisis is far from over.

CHC’s pro-active and flexible approach results in more work

Following the successful transition of the UK part of United Utilities’ non-regulated business to Veolia Water, CHC is pleased to announce that it has been awarded additional work with Veolia Water. Arwinderpal Heran, Performance Improvement Director at Veolia Water said that “Angus was tasked with ensuring the transition of 6 businesses, 180 new employees and 700 suppliers into the existing Veolia business and he met all his deliverables and objectives in the timescales and within budget. His pro-active and flexible approach was essential in delivering this project and I would like to thank him on behalf of Veolia Water for his support and contribution.” The additional work will enable CHC to help Veolia Water Procurement deliver the savings that have been identified as part of the integration while exploring new opportunities in indirect spend.

Headlines and highlife

If the number of headlines is anything to go by, then the surge in M&A activity that I wrote about a couple of weeks ago (2011 is a good year for M&A and is getting better) seems to be coming to fruition. The most eye-catching of the headlines this week have been those about News Corp and British Sky Broadcasting. It’s not all good news for those of us involved in M&A. Although Jeremy Hunt, the culture secretary, announced that he is not going to refer the deal to the Competition Commission, BSkyB’s shareholders want a lot more money than News Corp is currently offering. Also, Tony Jackson commented in the FT on Monday that Ashley Steele, a former colleague at KPMG, had seen the passenger numbers at Heathrow fall last year because it had been a quiet year for M&A. The evidence is necessarily anecdotal but interesting none the less. All the signs suggest that Heathrow should fair better this year but it should not count its chickens just yet.

Category management qualities

There’s a great article in Supply Management (“Divide and concur” 17 February 2011) about category management.  The article states that just 10% of companies considered their implementation of category management to be successful (Eric Evans & Associates). It goes on to clearly set out the difference between the skills required for category management and those used in “traditional” buying. In addition to good communication skill, commercial awareness and market intelligence, it states that category management requires:

  • Leadership to run cross functional projects
  • Change management to convince people of the need for change
  • Strategic vision to understand how the category management strategy aligns with the overall business goals

Unfortunately there are a lot of quotes that I’ve seen many times before such as “category management is more strategic and holistic than traditional buying”, that “more engagement from the business is required” and training is needed for buyers. There is, however, one quote that really stuck out. Rebecca Howard, associate director at ADR, says that category management means that you’ve got to “be really good with numbers” because it’s important “when it comes to cost analysis”. I think the importance of this is often overlooked and means that procurement doesn’t maximise its impact.

Category management is challenging and does require a lot from an individual. If, however, it is implemented effectively then it can drive the rest of the business. For me, this is the key to procurement getting representation at board level.

2011 is a good year for M&A and getting better

The FT reported (“Big merger sceptics ready for deal rush” 21 February 2011) that deal volumes so far this year are higher than last year ($99bn compared to $87bn) and that big investors are bracing themselves for a rush of mergers. The highest proportion of deals occurred in the energy and power industry (20%) followed by Financials (15%) and Materials (11%).

It also reported that a survey by KPMG based on the period from 2007 to mid 2009 showed that a third of takeovers (31%) boost the share price, a third (37%) have no effect and a third (32%) “ravage” value. KPMG’s global M&A predictor suggested demand for M&A is highest in the telecoms sector where forward price to earnings ratio has crept up and that the sector benefits from a net cash position. Another study by Towers Watson and Cass Business School shows that companies with a history of deal making outperform that market in the short and medium term. 

Once again, I think this highlights that M&A is a risky activity and that it is important to hire an experienced team.

Getting smarter about M&A

Anyone interested in business in general or M&A in particular should read the article in the HBR called The Big Idea: The New M&A Playbook by Clayton M. Christensen, Richard Alton, Curtis Rising, and Andrew Waldeck (March 2010). It contains a useful summary of some of the statistics around M&A such as companies spend more than $2 trillion on acquisitions every year and study after study puts the failure rate of mergers and acquisitions somewhere between 70% and 90%. It goes on to provide some analysis to explain the abysmal statistics. In short, the success or failure of an acquisition lies in the nuts and bolts of integration. What makes this article different from many others on the same subject is that it sets out a robust theory that identifies the causes of those successes and failures.

The authors identify two reasons to acquire a company. The first, most common one is to boost the company’s current performance either by helping it hold on to a premium position or to cut costs. The authors call this “leverage my business model” (LBM). For this kind of deal, CEOs are often unrealistic about how much of a boost to expect, pay too much for the acquisition, and don’t understand how to integrate it. This is where CHC can help. Apple’s $278 million purchase of chip designer P.A. Semi in 2008 is an example of just such an acquisition. Apple historically had procured its microprocessors from independent suppliers. But as competition with other mobile-device makers increased the competitive importance of battery life, it became difficult to optimise power consumption unless the processors were designed specifically for Apple’s products. This meant that to sustain its price premium, Apple needed to purchase the technology and talent to develop an in-house chip design capability—a move that made perfect sense.

The second, less familiar reason to acquire a company is to reinvent your business model and thereby fundamentally redirect the company. The authors call this “reinvent my business model” (RBM). Take, for example, information technology giant EMC’s acquisition of VMware, whose software enabled IT departments to run multiple “virtual servers” on a single machine, replacing server vendors’ pricey hardware solution with a lower-cost software one. Although this offering was disruptive to server vendors, it was complementary to EMC, giving the storage hardware vendor greater reach into its customers’ data rooms. When EMC acquired VMware, for $635 million in cash, VMware’s revenues were just $218 million. With a disruptive wind at its back, VMware’s growth exploded: Annual revenues reached $2.6 billion in 2010. Currently, EMC’s stake in VMware is worth more than $28 billion, a stunning 44-fold increase of its initial investment.

The poor success rate is borne out of the fact that executives often confuse the reasons for acquiring a company. As a result they pay too much and fail to integrate them properly.

 To read more, follow the link

CHC website is launched

The website was launched on 14 February 2011, and in the end, it felt very much like a labour of love. 

I would like to thank the following people: Andy from 146 Design for guiding a novice through the process of web design, Claire for deciphering my notes and writing the copy, Adrian for pointing out the areas that could be strengthen, Mat for making the best of a bad job and taking a decent photo and finally Fiona for developing the marketing strategy and providing constant support.

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