Jeremy Bowley, Managing Director of Insider Pro
The commotion in the Suez canal has brought into sharp relief just how vulnerable businesses all over the world have become to highly integrated but extremely fragile global supply chains.
The electronics industry is particularly interesting. Many components like PCBs are relatively easy and cheap to produce so there is a range of suppliers in the market. But for the most complex elements, like microchips, the R&D demands, the capital costs and the associated economies of scale have driven consolidation to the point where there are very few producers. Sometimes only one.
This means that UK manufacturers have several points of potential failure built into their supply chains. There are three key risk areas. First there is simply exposure to events. If you have a large consignment of parts on a single ship coming from far away and something happens, like the Suez incident, then you could suffer weeks of unexpected delays and will fail to meet your delivery contracts with your customer. A coup, a war, or the sudden imposition of trade barriers could have the same impact – think Myanmar or Brexit, or the current spat between the UK and China.
Secondly, there is the question of ownership of the value – how easy is it for you simply to find an alternative supplier? You might have the ability to switch suppliers in theory but in practice is it really possible? I often see companies completely dependent on one single supplier for a key part of their product because they have not thought more creatively and understood that that part is itself really just an assembly of otherwise pretty standard components. It might cost a little bit more to make it yourself but suddenly you’ve taken a big chunk of risk out of your business and the value that creates is worth more than a basis point or two off your margin. Sometimes lowest cost isn’t the right answer.
Thirdly it’s absolutely vital to be able to predict future demand and come up with plans well ahead of time to meet them. Scaling up always means stress-testing your supply chain, rather than simply expecting it to grow with you. If your suppliers don’t have capacity, don’t blame them if they can’t keep up. In other words, you have to have an eye on your suppliers’ businesses as well as your own. Minor problems can quickly balloon as you get bigger.
Companies that have not addressed these three risks have very reactive supply chains. I see it all the time. A reactive supply chain means you are always worrying about whether you can fulfil your orders for the next three months, not whether you can meet your two-year sales targets.
Potential investors pay less for vulnerable businesses so there is a huge payoff in removing these risks. If you are already doing things right, with a flexible, agile supply chain, you are more attractive to potential buyers. Remember that trade buyers will typically pay more for a business than private equity will. The PE investor looks for a company he can ‘fix’, snaps it up at a low price and then sells it on to a trade buyer at a premium, trousering the profit. Cut out the middle man and capture that value for yourself! In my experience finance directors underestimate by half the efficiencies they can extract.
De-risking your supply chain is not an overnight fix – in my experience it takes an electronics company about eighteen months to get this right, but it will boost the multiple of profits a buyer will pay. That’s a quicker route to a bigger valuation than simply growing your profits. For example, if you manage to increase your profitability 10% but you don’t increase your multiple, then your business is worth 10% more. Not bad. But if you can also get the multiple of profits a buyer would be prepared to pay from 5x EBITDA (operating profit with depreciation added back) to 6x, you’ve just added another 20% right there. Suddenly your business is worth a third more!
The UK economy is about to take off as the pandemic fades. We are going to see a dramatic rebound in manufacturing that will push sales and profits higher. As we ride that wave it will be really tempting to put off until tomorrow fixing those deeper structural issues and just make hay while the sun shines. Don’t succumb!
