Buying in Bulk

During a 2005 speech in San Francisco, David Rubenstein of The Carlyle Group got asked if there was a tangible difference between mega-LBO firms and corporate conglomerates. He acknowledged some obvious similarities, but added one big distinction: LBO firms don’t acquire to indefinitely consolidate – they acquire to ultimately sell.

Here’s another: Corporate conglomerates traditionally do a better job thinking of their assets as a collective. In other words, they are more likely to centralizing shared services, and to generate cost savings by obtaining bulk discounts on everything from shipping to office equipment to healthcare.

As Rubenstein suggested, one reason for this dichotomy is that LBO firms plan to sell portfolio companies, and there can be two problems with portfolio-wide bulk discounts: (A) Are the discounts portable, and (B) If not, will it be difficult for potential acquirers or the public markets to factor non-discounted fixed costs into their valuation assumptions?

But certain firms are beginning to answer those questions, and therefore increase operating margins throughout their entire portfolios (or at least most of it). One notable example is The Riverside Company, which probably has done more acquisitions than any other PE firm so far in 2007. It actually began the process around three years ago, and today its participating portfolio companies receive a 30% discount of FedEx shipping and a 10% discount on healthcare (it originally used Blue Cross for healthcare, but now uses what I think is the first-ever dedicated private equity product from UnitedHealth).

Riverside COO Pamela Hendrickson says that the portability problem is solved in different ways for different programs, but that they generally allow Riverside portfolio companies to maintain the discount post-exit, so long as they continue to use the same vendor. Patrick O’Keefe of UnitedHealth adds that, in general, his group’s program allows companies to maintain their discounts for 12-24 months post-exit. He adds that if the buyer is a large strategic, it probably would have it’s own negotiated bulk rate (i.e. portability would be irrelevant).

What is strange, however, is that relatively few private equity firms are exploring bulk discount options. Hendrickson says that during a recent private equity CFO/COO conference, the audience was asked to raise their hand if they were considering such a move in the next year. She reports that just around 15% of attendees raised their hands. It obviously doesn’t work for a small firm – too much in-house administrative overhead – but should be a no-brainer for firms with around $300 million or more per fund.