Enhance your organization’s value (Originally published on Finance & Commerce)
While customer concentration has been a largely scrutinized data point in M&A transactions, the supply chain issues of the last couple of years have revealed its, often ignored, ugly stepsister, vendor concentration.
The economic consequences of enterprise risk management (ERM) on a company’s overall enterprise value are well established. Indeed, evaluating and reducing supply chain risk is a component of overall enterprise risk management implementation. Interestingly, for years, public companies and M&A decision-makers have been concerned with “customer concentration” to the extent it existed, as a well-established risk factor. High customer concentration opens the potential for sharp losses. If a client goes out of business or decides to shop around, companies will need to compensate for the sudden loss of revenue. Empirical research has shown that supply chain disruptions cause an average of 107% drop in profitability (operating income), bringing about 7% lower sales growth and an 11% growth in costs.
Since COVID, geo-political risks, labor shortages, and related supply disruptions, “vendor concentration” has revealed itself as an underlying omnipresent risk. In fact, given its adverse impact on revenue and profitability, supply chain risk has proven to be more impactful to a company’s overall risk profile.
Over the last 40+ years, “just in time” inventory (JIT), vendor concentration, and increased reliance on non-domestic took hold as an “acceptable” strategic risk within corporate America. Successful just-in-time manufacturing, by eradicating excess stock, eliminated the need for storage and cut fat from the supply chain while also preventing pileups of finished but unsold products. JIT worked brilliantly under ideal circumstances and became a trusted cost savings method. Just as a sales team may rest on their laurels when they know a customer has high switching costs, procurement officers have historically resisted the rigor of due diligence and backup plans needed to ensure their suppliers will come through
The COVID pandemic revealed the financial fallacy and associated risks inherent in those short-sighted financial decisions by penny-wise and pound-foolish companies.
“As a result of the supply chain disruptions to U.S. companies, the CHIPs act is certainly a strong and needed step forward in assisting, especially U.S. manufacturers and the U.S. economy to ween off the unfortunate consequences of “just in time” inventory, vendor concentration and reliance on non-domestic manufacturing. “ Loren Unterseher, managing partner of Private Equity firm Oxbow Industries, comments. “However, it seems logical and frankly fair for the U.S. manufacturers to bear some of the financial burdens that resulted in the harm caused by their implementation of JIT, vendor concentration and reliance on non-domestic manufacturing. U.S. manufacturers need to partner with the U.S. Government to assist the U.S. economy in righting the situation that corporate America created.”
Minimizing vendor concentration, dual sourcing, and decreasing reliance on non-domestic manufacturing mitigates the overall risk profile of any company. Moreover, the financial benefits of increased revenue and profitability are apparent. However, with those benefits, there are corresponding financial burdens. This will require U.S. companies to invest in mitigating supply chain risk by sourcing products from domestic sources. This may increase the overall cost and require capital investment in domestic sourcing. However, due to the reduction in the overall risk profile, the company’s profitability is higher and more predictable, and the (P/E) enterprise value will increase.
Leah Berend is the Chief Financial and Chief Administrative officer of Oxbow Industries.
With over $2.5 billion in corporate financial transactions completed, Oxbow Industries is dedicated to building businesses in partnership with their management teams. Oxbow seeks to invest in leading middle-market companies with outstanding leadership teams and a significant opportunity for equity appreciation. Learn More at OxbowIndustries.com