|David Finch, President
and Founder of Insight Collaboration Partners
We found this article to be so timely, given the volume of M&A that has occurred so far in 2016: already more transactions logged year-to-date than were completed for full-year 2015. —Editor
The primary foci for the due diligence phase of many M&A projects tend to be financial review, portfolio fit and savings potential of post-close synergy opportunities, which typically means headcount reduction. What is often overlooked is the identification of risks for disruption and opportunities to leverage supply chain infrastructure to ensure that, after closing, the acquirer will be able to sustain or enhance uninterrupted and efficient upstream and downstream product supply.
Here are three areas that should be included in a robust due diligence plan to avoid post-close surprises and costly supply chain failures.
People and Systems
These often fall into the “we’ll figure it out later” category and are not given the attention equivalent to the risk that they pose. One reason cited is the need to maintain confidentiality in the early stages of negotiation, especially prior to public announcement of intent. This is certainly of concern, but is not an acceptable excuse to avoid investigating areas such as:
People - Acquiring companies will identify key managers whom they want to retain, but may miss lower level contributors who possess critical knowledge and experience in systems and processes—sometimes referred to as “tribal knowledge.” Knowing why can be more important than how when it comes to understanding the legacy systems and processes in place at the target company.
These people are often system administrators or “super users,” and can be identified through inquiries concerning the most knowledgeable person on the planning system, forecasting, suppliers and other critical supply chain processes and functions, in addition to length of employment and breadth of both horizontal and vertical experience.
You should pay particular attention when the same name comes up over multiple areas. Often these individuals are critical in that their knowledge cannot be replaced by “system experts” or integration consultants, and may be lost in headcount reduction if seen only as a duplication of similar responsibilities within the acquiring company’s organization. In addition, the impact of their loss may not be seen until months after closing, when something fails or does not work as expected.
Systems and Processes - Review of the target company’s financials typically includes the financial reporting or Enterprise Resource Planning (ERP) system, and its compatibility with the acquiring company’s systems, but may not include the supporting supply chain systems. These elements would include forecasting, planning, warehouse management, logistics and customer service, which may or may not be integrated into the ERP. Of particular concern should be standalone systems, especially if designed, created and maintained solely by company associates.
Both the systems and the maintainers of those systems need to be included in your risk plan. A disastrous example of this would be an acquiring company that does not send invoices to customers for six months, because invoicing required a manual step that was not being completed, as the person responsible for it had been lost post-close and no one else was aware that it was required. The company may never fully recover from the associated losses.
Upstream Supply Chain
Your upstream due diligence requires more than just a review of suppliers and purchased items for fit into the acquiring company’s procurement strategy. A robust due diligence plan should also include review of:
Exclusive Supply Agreements - In addition to restrictive terms that limit post-close consolidation plans and supply cost negotiation, these agreements may include supplier IP and, in some cases, royalty payments and deferred R&D reimbursement that will increase total material cost and impact planned margins.
This is often true of smaller or startup companies where limited internal resources and cash may require them to offer a share of future profits or product ownership for help today with completing the product’s development or regulatory submissions.
Design Ownership - Do not assume that the target company owns the designs of all procured materials and products. This may require a request specifically for this information and a detailed review of select drawings. Like exclusive supply agreements, this could impede post-close consolidation, including in-house manufacturing as well as design control and regulatory submissions.
Drawing and Specification Clarity - Due to time constraints and the nature of the due diligence process, you may not be able to complete a thorough review for incomplete drawings and vague specifications. If able, you should first focus on older legacy products, especially if they have been manufactured by the same supplier since released, as these tend to have the highest risk for this issue. Missing detail and interpretive or visual standards are two issues to look for.
Procurement Systems - Not only the software that is being used, but also the way that it is integrated into the forecasting/planning system—or not—as well as the accounting system. All of these could be standalone and require duplicate data entries, and be difficult to keep in sync, much less integrate into the acquiring company’s system.
Special Handling and Storage Requirements - These special requirements could impact both your upstream and downstream supply chain. In addition to higher freight and handling costs, they could require capital investment as well as extensive validation and regulatory submissions if changed. This is especially true for fragile and temperature-controlled products.
Expiration and Obsolescence - Like special handling and storage requirements, this could impact both upstream and downstream inventory. In addition to financial impact of unplanned disposal, they can cause disruption in supply and thus affect your newly-acquired customers.
An easy method for assessment is to include a minimum shelf life in your review of inventory, as well as balance of that inventory based on the historical demand curve.
Downstream Supply Chain
You can’t let the customer feel your pain. This is especially true post-close due to heightened concerns that customers may have related to the merger or acquisition. Your review should include the identification of issues related to the target company’s historical performance, as well as how you will assure a scalable and reliable order-to-service process post-close that will meet and exceed customer expectations. To do this, you need to assess:
Forecasting, Planning and Inventory Management - These represent the voice of the customer and your ability to meet their demand, as and when expected. Like the procurement system, these may each be standalone, increasing the opportunity for failure and additional cost to keep them in sync.
Be cautious of forecast accuracy claims at product family or product line levels, as they can be subject to manipulation and misrepresent serious issues at lower levels. You may also want to see results of the last several cycle counts or physical inventories for both number and trends of errors. Include the same level of scrutiny as the upstream inventory for expiration and obsolescence.
Order Entry and Customer Service Systems - Failures here can be an indication of deeper issues in forecasting, planning and inventory systems. Key concern in this area is integration with the supply and inventory systems. Just imagine committing delivery to a customer, only to find that not only is it not in stock, but will not be for an extended period of time.
Outbound Logistics - This should include both method as well as special handling requirements and restrictions. As with inbound, this is especially true with fragile and temperature-controlled or monitored product.
Also, be mindful of the freight handler, as it may be a company with which you do not have favorable shipping terms, but is critical for on-time delivery to the customer. “Next day delivery” has numerous definitions, and performance metrics will vary by carrier.
Product Registration - In some countries, the regulatory approval and registration process can be expensive, restrictive and take years to complete. The time to discover issues in this area is during due diligence, not when you are about to launch a major market expansion. In addition, issues found in this area may have a major impact on the financial feasibility of the merger or acquisition.
Your company wants to sustain uninterrupted and efficient product supply, post-close. To avoid costly disruptions, as well as poor post-close customer service and financial performance, it’s imperative that you identify supply chain risks during due diligence. This should include review of the people, processes and supporting systems for upstream and downstream supply chains. Adding these to your due diligence checklist, or working with a partner, will help to assure that you don’t miss any critical areas.
This article originally appeared in BONEZONE®.
For further M&A insights, see "The Seven Phases of M&A" by Don Urbanowicz (ORTHOKNOW September 2014). This article highlights the typical process of buying a company, with specific context for buyers and sellers who may be new to the process or are interested in picking up a few tips.
David Finch is President and Founder of Insight Collaboration Partners, a consulting firm that assists companies in due diligence and post-acquisition strategy implementation, strategic sourcing, intra- and inter-company collaboration and improving operational efficiency and cost.
Mr. Finch has more than 30 years of hands-on experience in global supply chain and manufacturing operations in the medical device and orthopedic industries with Becton Dickinson, Johnson & Johnson, Wright Medical and MicroPort Orthopedics. He can be contacted by email.