By Bill Remy
To rapidly improve the performance of portfolio companies, operating partners should focus on three types of opportunities. Each can improve profitability by reducing cost structures, lowering break even points and improving margins.
One-time performance gains in a manufacturing business include plant consolidation, supplier rationalisation, and reducing inventory levels, which will lower operating expenses, material costs and working capital requirements, respectively. Aggregating spending across business units to achieve volume-based price concessions is another example.
These opportunities exist in all businesses and frequently deliver substantial financial benefits. The trick is identifying which ones will have the biggest impact on earnings. While the potential operational and financial impact can be significant, they require effective planning and project management to fully capture. Such projects usually require six months to a year to execute before the savings can be fully realized.
The benefits from these performance gains – if they are sustained – accrue from month-to-month like annuity payments. Examples of such benefits include reducing scrap rates, improving quality, increasing productivity and improving overall equipment effectiveness (OEE). Operational excellence and continuous improvement efforts tend to focus on these areas.
After such process improvements are implemented, many companies struggle to sustain the new performance levels. That’s because management practices and behavior have not been changed to support the new procedures or to drive ongoing improvements beyond the new baseline.
This brings us to the third, and often neglected, target area for driving significant performance improvements: How the portfolio company is managed on a daily basis. We refer to this as a “management system.” When assessing potential business improvements and setting priorities, because few companies actively develop their management system, private equity firms sometimes overlook poor day-to-day management practices.
Signs of significant opportunities include many short production line stoppages, and long equipment changeovers. Other examples are habitual rework, excessive operator movement, and the intermittent disruption of material flow because of poor line-stocking practices.
These seemingly minor miscues and process failures can add up over the course of a single shift or week. Accustomed to their fire-fighting roles, plant management doesn’t see the improvement opportunities hidden within these seemingly insignificant losses. Accounting for the extra effort required by associates and supervisors to respond and ship quality products on time, these performance leaks can reduce daily productivity by 5-15%.
Eliminating these performance leaks is essential for realising the full financial returns from your efforts to improve portfolio company performance and grow earnings. This leakage will undermine process changes and performance gains. Like a slowly leaking balloon, without oversight and reinforcement, it doesn’t take long for new processes to be forgotten and performance to regress to previous levels. Does this sound familiar?
Many companies don’t even recognize that their management system can be improved. Minor process failures and rework are symptoms of poor management discipline, but not necessarily poor management capabilities. Changing management team members won’t solve the problem on its own.
A cornerstone of our private equity practice is helping clients implement a disciplined management system for eliminating these failures and establishing a culture of excellence. Of course, this sometimes requires new management. But existing managers can often drive change with a deeper understanding and support for what needs to be done.
Establishing a more effective management system may not sound very new or earthshattering, or capable of generating the type of value that investors expect. It is however, as I will explain further in my next post, essential for growing earnings of portfolio companies and realizing the full financial potential when it’s time to exit.
Read Other Blog Posts by Bill Remy
There’s No Autopilot Mode for Operational Excellence
Maximize Private Equity Returns By Getting Leadership Right from the Beginning
Private Equity Operational Due Diligence + Value Creation
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