By Joseph Esteves, SGS Maine Pointe
When examining the performance of private equity portfolio companies, a consistent demand for products or services may initially appear as a positive sign. However, demand is inherently volatile and subject to various factors such as economic downturns, shifting consumer behavior, and unexpected global crises, which lie beyond the control of private equity sponsors and portfolio CEOs. However, it’s how companies create value during these times that are the real indicators of sustainability.
During inevitable periods of demand fluctuation, businesses face immense pressure to adapt swiftly and seek effective strategies that not only address the immediate issue but also prepare them for the future. Portfolio companies have the opportunity to create enduring value by uncovering avenues for strategic cost reduction and enhancing efficiencies, all while mitigating risk and improving cash flow. Embracing a mindset that moves beyond mere reactions to temporary demand disruptions allows businesses to foster lasting value, growth, and an environment of operational excellence capable of withstanding the test of time.
Discovering opportunities for strategic cost savings
While reduced demand may impact profitability, it can be balanced by identifying cost-saving opportunities. These savings can be realized across three distinct areas: procurement, logistics and operations.
In times of abundance, procurement optimization may take a backseat as orders flow in seamlessly. However, adopting a strategic approach to sourcing can generate value creation ranging from 8% to 12% from supplier margins, not simply taking into account deflationary market movements.
Consider the case of two steel fabricators undergoing a post-merger integration. The newly formed company re-evaluated its procurement strategy for purchasing steel. Strategic sourcing, neglected during times of sales growth, became a focal point as demand plateaued. Through improved contract management, enhanced pricing visibility, and exploration of supplier options and alternatives, the company gained better control over steel costs and availability. The result was an incremental $15 million in real YoY savings and a sustainable 6.7% increase in EBITDA in the first year. It’s important to note the client will see an additional $20 million in savings from natural price reductions from commodity markets, however these “savings” will eventually be passed onto the customer, as customers demand price concessions due to the deflationary market we find ourselves in.
In an SGS Maine Pointe study, we have found that up to 50% of price increases passed on since the covid-era pricing frenzy cannot be directly linked to underlying factors such as raw material costs, labor, or freight. This presents a significant opportunity to revisit agreements/contracts and negotiate better pricing and terms, while exploring alternative suppliers that are hungry for your business. This flexibility brings multiple benefits, even if a company already has a preferred supplier.
Understanding the current landscape and alternative options available can strengthen your competitive situation. During the recent pandemic, companies with such supply chain optionality were able to survive long-term shutdowns of Chinese suppliers and challenges in foreign ports, however the power pendulum swung back to domestic producers. These domestic producers have benefited mostly from their pricing power, but the global landscape has changed. Global suppliers have reallocated supply chains and are hungry for your business.
Creating lasting value
As companies evaluate strategic sourcing opportunities to create value, they must look to achieve Total Value Optimization, our methodology which has been endorsed by the Global Supply Chain Institute as “The best approach [they] have seen to achieve integrated supply chain excellence in logistics, operations and procurement.”
Consider the case of a consumer goods client that was heavily dependent on China during covid, where factory closures disrupted supply chains and led to unmet customer demand and lost orders. By incorporating supply chain optionality, the company diversified its supply base, with 35% of the new suppliers located outside of China. This strategic sourcing not only resolved availability issues, but also by combining their efforts with logistics and operations, it improved overall costs, lead time, and quality. The outcome was $17 million in annualized cost savings and a remarkable 41% increase in EBITDA.
Steps for action
Every company will encounter unexpected demand anomalies. To safeguard against demand-driven lulls, portfolio company CEOs should continuously assess and adapt to a changing market landscape.
Navigating periods of reduced demand requires proactive steps rather than reactive measures. In this ever-evolving landscape, strategic navigation of reduced demand is crucial for survival and long-term success. Businesses must be agile, implementing new strategies and adapting quickly to thrive in times of change.