WHEN SUPPLY CHAINS MERGE: 5 MISTAKES TO AVOID

By Harpal Singh, Ph.D.

Most mergers and acquisitions fail to live up to expectations. All too
often companies focus on quick-fix cost-cutting opportunities and
ignore the long-term, strategic supply chain implications. Following
these five steps will help you avoid that trap.

Companies embark on mergers and acquisitions (M&As) with high hopes,
promising the financial community improved performance and greater
revenues. In reality, however, few M&As live up to expectations.
Recent research studies suggest that up to 60 percent of mergers have
a detrimental effect on the overall performance of the combined firm,
and fewer than 25 percent of all acquisitions achieve their strategic
objectives.1

Part of the reason for this lack of success may be that many companies
ignore the hard work of establishing an effective and efficient
consolidated supply chain.

Everyone agrees that effective manufacturing and logistics practices
are crucial for improved financial performance. Yet many of the
typical tactics for increasing productivity and reducing costs post-
merger—such as closing plants, laying off workers, and reducing wages—
end up disrupting the supply chain and result in poor operational
performance and reduced revenue. Instead of short-term cost-cutting
measures, supply chain rationalization efforts should focus on long-
term productivity gains such as eliminating redundancies and creating
synergies. These long-term projects may include streamlining the sales
organization, merging product offerings, and consolidating the
production of intermediate components. In situations where there is
vertical integration (for example, between a manufacturer and a
distributor), there usually are more opportunities to create synergies
than to eliminate duplication. One area that deserves attention is the
inventory that is being carried between the manufacturing entity and
the distribution company. Often, this can be drastically reduced by
integrating the planning processes.

To identify these duplications and synergies, companies need to spend
time conducting a careful post-merger supply chain assessment. This
assessment should review the existing organization's structure,
identify improvement opportunities, and provide a list of steps for
consolidating systems and processes to increase efficiencies and avoid
disruptions. This assessment will form the basis for a supply chain
rationalization plan. While creating such a plan may sound like common
sense, companies often get tripped up on their way to realizing their
goal. We have identified five common mistakes that we have seen
companies make time and time again (see Figure 1). In this article, we
suggest some steps for avoiding these pitfalls.

Mistake 1: Choosing the wrong metrics
Creating an effective supply chain rationalization plan after a merger
is challenging. In an environment where many people may be feeling
uncertain and fearful of losing their jobs, it can be difficult to
create a consensus. To combat these anxieties, it is important to make
rational decisions based on quantifiable measurements and to make
these decisions as transparent as possible. For this reason, we
believe that every post-merger plan needs to create a set of common
metrics. Common metrics allow the post-merger organization to compare
the legacy supply chains in a rational manner and to assess which
parts should be kept, which should be completely eliminated, and which
need to be modified.

Choosing the right metrics, however, can be more difficult than it
sounds. Supply chain metrics vary from one organization to another.
For example, one company might measure delivery performance against
the customer's desired date, while another may measure delivery
against a negotiated delivery date. Even if the two firms use the same
metric, they can have very different interpretations. "On-time orders"
in one firm might mean on-time deliveries to the customer; in another,
"on-time orders" may mean ontime shipments. A key part of defining
consistent metrics is clarifying the supply chain definitions used by
the merging companies.

If the merging entities have different product and capacity profiles
or serve different sections of the market, the problem of choosing the
right metric becomes even more troublesome. Consider, for example,
product transitions. In one firm, the manufacturing process might
employ large runs and infrequent product changes. Another company
might have a more flexible manufacturing process with short product
runs and frequent product changes. Although the first company may
indeed have lower transition costs per unit of product made, it may
not be the more efficient operation because the manufacturing process
requires larger inventories to buffer the long production runs.

To avoid making unfair comparisons, companies should choose those
metrics that can be supported by available data, provide a useful
level of precision, and are backed by common definitions. Keep in mind
that these metrics need to be established quickly. For this reason,
data availability should be the overriding concern, rather than
finding the perfect metric.

Companies should start by establishing common metrics in three areas:
financial performance, supply performance, and delivery performance.
While there are many useful metrics available, we recommend the
examples listed in Figure 2 because they typically can be supported
with data that is readily available.

Let's pause to take a particularly close look at our suggested
financial metrics. To assess the financial performance of the supply
chain, we recommend using "variable supply chain cost per shipment"
and "inventory turns." Normally, the "cost per shipment" includes
order-processing costs, technical support, inventory costs,
warehousing costs, transportation costs, taxes, and the overhead
assigned to supply chain planning. We suggest, however, that firms
exclude the assigned overhead components from this comparison because
those costs reflect a pre-merger organizational structure. To compare
the efficiency of supply chains, it is more meaningful to look only at
the variable costs.

Another commonly used measure to compare supply chain efficiency is
inventory turns. While not strictly a financial measure, inventory
turns often are treated as such by many companies because they reflect
the amount of working capital needed to support sales. Together with
receivables, inventory turns account for a significant amount of cash
that the firm needs for its operations. In a merger and acquisition
situation, companies pay a lot of attention to inventory and
receivables because they represent two areas from which cash can be
freed up relatively quickly. Inventory turns, however, should never be
used if the merger represents a vertical consolidation of supply
chains. For example, if a manufacturer merges with a distributor,
comparing the inventory turns of the distributor and the manufacturer
would be meaningless.

Mistake 2: Trying to consolidate systems too soon
Assessing the legacy supply chains does not just require common
metrics; companies also need to have consistent data. Many companies
mistakenly believe that the only way to get consistent data is to
consolidate their legacy supply chains' transactional systems (such as
the order entry systems and the financial reporting systems). As a
result, they rush into system-consolidation projects that can quickly
become expensive, counterproductive, and overwhelming—especially if
the new combined system is expected to simultaneously accommodate the
different business processes of the merging entities.

There is an alternative. We recommend that companies build a common
database that combines transactional data from the inherited systems.
Every modern database program provides relatively simple tools that
can be used to bring together disparate transaction systems. Often it
requires as little as four to six weeks to address key supply chain
management reporting requirements around production, production
reliability, inventory allocation, demand variability, and order
fulfillment performance.

The database can serve two purposes. First, the new database becomes a
repository for documenting the differences in how the merging entities
interpret their data. It provides a platform for addressing
transactional discrepancies like duplicate product names, different
cost allocations, and alternate data interpretations.

Second, the database can take transactional data (such as orders,
production information, purchases, and requisitions) from the existing
systems and apply the appropriate rules and interpretations to make
the data consistent. The database then provides the basis for
calculating and reporting on the common metrics that are defined for
the merged company. Consolidating the data immediately provides
visibility to management without having to tackle the issue of
changing the entire systems infrastructure.

Mistake 3: Paying too little attention to the planning processes
Armed with common metrics and consistent data, companies can begin the
important step of conducting a post-merger supply chain assessment.
The goal of the post-merger supply chain assessment is to:

  1. Review the existing organizational structure and identify
improvement opportunities;
  2. Assess each pre-merger entity's competence in five key areas:
understanding demand, managing inventories, planning demand, planning
production, and scheduling; and
  3. Provide a list of steps that describe how to consolidate the
systems and processes to increase efficiencies and avoid disruptions.

Frequently, however, companies make the mistake of restricting any
post-merger assessment to the feasibility of consolidating transaction
systems and combining transactional functions like order taking. Our
contention is that these efforts are often misplaced. Supply chain
efficiency is primarily determined by the planning and decision-making
processes because these processes affect how well a company can react
to the changing environment and how well it allocates resources to
meet business goals. The post-merger supply chain assessment should
rightly be focused on the planning processes.

Planning processes are best assessed over three dimensions:

  1. Integration: The level of integration within planning processes
is determined by how much of the supply chain is simultaneously
planned. Simultaneous planning of purchasing, transportation,
inventory, and manufacturing indicates a high level of integration.
  2. Optimization: Optimization refers, in part, to whether or not
the options offered during the planning process are quantified. The
greater the sophistication of the quantitative framework used for
planning, the higher the level of optimization.
  3. Acceptance: Acceptance of supply chain planning refers to the
extent to which the planning processes are institutionalized. By this
we mean that the planning processes are used to assess how to react to
changes in demand or to supply disruptions. If the processes are not
institutionalized, companies tend to develop a parallel and somewhat
subjective response to a crisis that ignores the longer-term
consequences.

We have found that it is possible to grade supply chain planning
processes on a five-point scale for each of these three factors. Often
this is sufficient to identify the strong and weak points of the
existing processes.

Although companies should focus their assessment on the planning
processes instead of rushing to consolidate their systems, it's still
necessary to evaluate the transactional systems that they are
inheriting. Because many companies have adopted modern enterprise
resource planning (ERP) systems, most supply chains already have in
place a basic transaction management infrastructure like production
and inventory recording. The systems, however, should still be rated
for transactional integrity and data visibility. Transactional
integrity refers to how well the transactions within the ERP system
represent the current state. For example, if the transactions are
"batched" (entered once a day or less frequently), the system does not
have as a high a level of integrity as an ERP system where
transactions are entered in real time. Data visibility refers to the
extent to which the data is available and usable by supply chain
planners. A high degree of data visibility indicates that schedules,
inventory levels, future plans, and costs are readily available and
accessible. Assessing these two factors will indicate which
transactional systems should be modified or eventually be replaced.

Mistake 4: Defining the end state but not the steps to get there
After conducting an assessment, it is common to define a desired
state, or how the resulting merged supply chain should look. Many
corporations, however, make the mistake of trying to replace existing
systems and processes all at once to achieve that desired state. This
strategy increases the risk of disruptions, especially in a post-
merger climate. The assessment should indicate not just the end state
but a series of steps to move toward that end state.

To accomplish this, a joint team should be appointed to recommend both
short-term savings and longerterm productivity improvements.
Typically, such a team will be led by the supply chain organization,
with representation from finance, manufacturing, logistics, and
information systems.

This team will use the results of the post-merger assessment as a
guide for the recommended longerterm changes. The changes should be
broken down into a series of projects lasting three to four months
each. Together these projects will constitute a road map for combining
the supply chains and delivering productivity gains.

The team's charter should also empower it to execute short-term
improvement projects that require a minimal investment but promise
quick payoffs in terms of delivering cash. When this does not happen,
separate, uncoordinated initiatives tend to sprout in different parts
of the organization because of the pressure to quickly create
financial benefits.

Mistake 5: Failing to consider the degree of disruption
Each of the projects that the team recommends needs to stand on its
own in terms of delivering the required business benefits and a return
on investment. The one additional factor that should be considered in
the postmerger environment is the degree of disruption. Not doing so
can lead companies to make rash decisions. For example, the benefits
of IT integration usually are quantifiable, and companies frequently
try to accelerate the integration to achieve these gains.
Unfortunately, they often do not consider the cost and revenue impact
of potential disruptions until problems have already arisen.

In addition to assessing potential internal disruptions, companies
should also consider the possible disruption to customers. In a post-
merger environment, customers are often anxious and afraid that their
interests may be compromised in the rush to achieve post-merger
benefits. It is helpful if the initial projects are primarily focused
on delivering better customer value and if this focus is clearly
communicated to the customers.

This last point is key. Any disruption following a merger or
acquisition can increase customers' anxieties, leading them to take
their business elsewhere. By avoiding the mistakes discussed above,
companies increase their chances of executing a successful supply
chain merger. A careful post-merger assessment and project-
prioritization process will keep them focused on achieving long-term
productivity gains instead of chasing short-term cost savings. With
this framework in place, companies are more likely to deliver the
financial benefits that are expected from a merger. Without it, they
risk becoming yet another M&A that failed to live up to its promise.

Endnote
1. According to a recent study by Robert Holthausen, a professor of
accounting and finance and academic director of mergers and
acquisitions at the Wharton School of Business, probably 60 percent—
and some estimates are as high as 80 percent—of acquisitions fail to
create value for the acquirer.

As the co-founder and CEO of Supply Chain Consultants, Dr. Harpal
Singh has been the chief architect of the firm’s technology vision,
which focuses on the integration of supply chain strategy and tactics.
In addition to years of industry and consulting experience, he has
taught graduate and undergraduate courses as well as executive
management seminars. He holds a Ph.D. from Cornell University.

Source:
http://www.supplychainquarterly.com/print/scq200902merger/