Academic journal article The McKinsey Quarterly

Purchasing's Big Moment - after a Merger

Academic journal article The McKinsey Quarterly

Purchasing's Big Moment - after a Merger

Article excerpt

Savings can amount to half the acquisition premium

Ensuring that reduced costs actually get to the bottom line can be as challenging us mining for gold

Five mistakes to avoid

After an acquisition or merger, senior managers often find themselves under pressure to return benefits to shareholders - particularly one company has paid a high premium for another. Synergies between companies and economies of scale are regarded as prime sources of value creation. Yet frequently the benefits fail to materialize: research indicates that up to 60 percent of mergers fail to create shareholder value within 10 years.

In many mergers and acquisitions, however, a potential goldmine of unexplored shareholder value exists in the form of purchasing and supply management (PSM). Our experience suggests that close attention to PSM can reduce by 10 to 15 percent the total cost of goods and services purchased by merged companies. An analysis of 50 recent high-value mergers and acquisitions shows that savings of this magnitude can recoup at least half of the merger premium, although the more scope there is for PSM improvements, the bigger the payback.(*) If there is room for improvement in both companies, the premium can be more than offset, with a surplus of pure shareholder value.

So powerful is PSM that in a recent merger of two US utilities, approval from state and federal regulators was facilitated by projections showing that savings of almost $1 billion could be made over 10 years, almost half of which would come from PSM. In another example, the senior managers of an electronics company gained the confidence to go ahead with a merger on the basis of estimated PSM savings. The actual savings they made offset almost two-thirds of the merger premium.

Yet many CEOs whose purchasing departments do no more than churn out orders are still blind to PSM's potential. "How tough can this be?" asked one during a recent merger. "Let's just compare price lists and take the better deal."

Taking advantage of the buried shareholder value that PSM represents is tough, however. Indeed, it is often overlooked because of the energy and diligence it demands. But the effort will prove worth while. Purchased goods and services ranging from office furniture to raw materials to outside contractors represent up to three-quarters of most companies' total spending.(*) And that proportion is increasing because of the trend toward outsourcing non-strategic activities such as payroll, call-center management, credit collection, materials management, and even product assembly and shipment.

PSM can therefore yield substantial savings for any company, merged or not. But it is particularly effective immediately after a merger or acquisition because of the sense of urgency and uncertainty that such an event creates. At that moment, the potential cost savings are greater and more easily captured. Every department or function is compelled to figure out how to integrate two sets of employees and procedures and meet aggressive performance improvement targets as quickly as possible.

As a result, all of those "We'll improve our PSM practices someday" ideas rocket to the top of employees' agendas. Given the urgency, departments unaccustomed to working with PSM can be inspired to enlist its help to identify non-labor savings (that is, savings that can be achieved without laying off employees). The traditionally low-profile PSM organization can thus be elevated to a position of importance in the new entity.

In a merger of two financial institutions, retail and corporate bankers worked with the new entity's PSM team to identify savings that could be made in such disparate areas as credit reporting, check printing, automatic teller machines (ATMs), and marketing brochures - all of them previously considered to be outside purchasing's responsibility. By such means as consolidating fragmented purchases (goods and services bought by too many people from too many suppliers), devising creative strategies for negotiating contracts, introducing new suppliers, and changing the patterns of demand (by, say, adjusting how much of a material or service was used and ordered at any given time), the team gained first-year savings ranging from 8 percent for ATMs to more than 20 percent for credit reports and marketing brochures. …

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