When supply chains merge: 5 mistakes to avoid

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.

Article Figures

[Figure 1] Five common post-merger mistakesEnlarge this image

[Figure 2] Suggested common metricsEnlarge this image

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.