Edition 58
M&A to Innovate
by Tom Racciatti, Senior Manager, West Monroe Partners

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In the age of rapid changes within healthcare, technology, bio-tech and other dynamic industries, the sometimes forgotten manufacturing & distribution (M&D) sector continues to look for new ways to produce existing consumer and industrial products more efficiently and to bring new products to the market. Despite being considered a stagnant industry in the minds of many, manufacturers, distributors and logistics providers must continue to innovate and adapt, especially as technology makes its way into M&D (in many forms, from the smart technology in your car or on your phone, to implanted medical devices). As manufacturers, distributors and logistics providers pursue these new markets, a slew of operational complications are surfacing – including a lagging experience curve position and unwinding the reverse logistics of new products to efficiently reuse or repurpose materials.

Should the focus of operators expand beyond their four walls and distribution channels? Operations-focused management teams throughout the M&D industry are intensely focused on trying to squeeze as many cents per unit out of their operations as possible (as opposed to pursuing more transformational business opportunities leading to innovation). Recent logistics-related points of emphasis have been on outsourcing and offshoring the labor-heavy components of M&D operations to reduce labor and personal protective equipment costs. This shift is now being reversed in the name of right-sourcing/re-shoring, which has emerged to address perceived productivity and quality declines from offshore operations. In the US, additional factors bringing back domestic labor include improvements in domestic energy production and costs, rising wages overseas, government incentives and the trend towards locating production closer to consumers. These kinds of efforts focused on fractional operations-based savings, while valid and powerful when optimized to significantly reduce the cost-to-serve your customers, can require massive planning and focus while carrying significant business risk and disruption. Instead of focusing solely on evolutionary unit cost savings, operators should also be allowed and encouraged to look for revolutionary business change by considering markets and product groups outside of the business’ current core industry, creating innovation through the combination of distinct business solutions.

The opportunity to selectively expand beyond your core industry was brought to mind upon reading about Lexmark International’s acquisition of Acuo Technologies right here in my backyard in Minnesota earlier in 2013. At its core, Lexmark is a manufacturer of laser printers; however, with a prior acquisition of Perceptive Software, Lexmark began to provide technology solutions to the healthcare sector. With the Acuo acquisition, Lexmark now offers better patient care, enhanced clinician experience and cost savings through an enterprise-wide platform for clinical content viewing (accessible by any electronic medical record system as a “Universal Clinical Platform”). It’s incredible to think that a printer manufacturer is changing and improving the way we are being cared for as patients, all the while returning 50% of free cash flow to shareholders.

The same trend can be seen on the “D” side of M&D, with distribution and logistics companies expanding into broader solution sets for their existing and new customers, as exemplified by Flextronics’ recent acquisition of RIWISA AG. Flextronics is a leading end-to-end supply chain solutions company that delivers design, engineering, manufacturing and logistics services to a range of industries. On November 4, 2013, Flextronics announced its acquisition of RIWISA’s state-of–the-art manufacturing facilities and highly-experienced employees in medical, consumer packaging and industrial products, thus expanding into injection molding from a distinct platform base of logistics services and serving as another example of cross-industry acquisition.

What does this mean for M&D corporate development? If innovation and external-industry insights lie outside of your organization, it may be time to look at a merger or acquisition to capitalize on these opportunities. This is not a suggestion for more standard horizontal or vertical integrations, but rather cross-industry integration. This is a recommendation to go against what’s being discussed in MBA classrooms around the country in terms of focusing exclusively on your core competency and considering anything beyond that a distraction from maximizing profit; rather, this recommendation and noted trend is to look beyond your core competency and determine how your company’s product(s) could fit a customer need if converged with another company’s primary focus.

Who should be thinking of industry cross-over within your organization? While identifying M&A opportunities often falls within the responsibility of a classic corporate development or strategic CEO role, cross-industry insights will likely require input from various internal functions. First, make sure you have strong collaboration between your supply chain operations and your sales and marketing team so that you truly understand the cost-to-serve your customers. Through a cost-to-serve exercise, you will understand where your profits lie and where you can improve your operations. But, equally important, you will open and establish the right lines of communication between both departments. The same philosophy of cross-function communication can be of value for cross-industry mergers and acquisitions. If you start with the voice of the customer (what is your sales and marketing team hearing from your audiences?), and then work back to product features from your operational leaders (COO, Director/VP of Supply Chain/Logistics), you can blend those perspectives to discover alternative and potentially disruptive solutions that might fill a need for current customers, or create demand from new ones. This internal collaboration can provide insights to drive outside-the-box prospecting and targeting of potential partners – well beyond the limits of your industry as it is defined today.

How are core operations affected? A negative experience curve position, “key man risk” and overall knowledge transfer are struggles associated with any transaction; however, these issues are even more critical when expanding outside of your core competency. Identifying, retaining and correctly positioning resources with inherent knowledge of the new market, product or features is paramount to successfully transition into a new industry – even at the sacrifice of short-term synergy wins through selling, general and administrative headcount reduction.

Often an afterthought in any transaction, reverse logistics can also play a large role in optimizing new operations – as the efficient reuse, sale or disposal of products related to cross-industry production can lead to important operating margin points and the closing of the experience curve gap with entrenched industry players (in the case of the market not being a new one created by your expansion). If returns management, remanufacturing, costly disposal or other reverse logistics issues exist in the new business, there are likely opportunities to cut supply chain costs, and more importantly, to foster customer retention through meeting customer/consumer needs in the event of merchandise returns. Analyzing reverse logistics data internally or through a third party logistics provider immediately following any significant change to your business will allow for appropriate course corrections and customization of your material flow patterns so you can enter your new market as a mature player.

Contrary to public perception, the manufacturing and distribution industry isn’t stuck in the past. Advances in technology and consumer demand have made room for M&D organizations to grow into agile, global competitors – but taking advantage of these opportunities might require firms to move outside of their comfort zones. By combining their primary strengths with those of businesses across industries, manufacturers and distributors can tap into new talents, new ideas and a new mode of operating.
Tom Racciatti is a senior manager in West Monroe Partners’ mergers and acquisitions practice and is based in the firm’s Minneapolis office. He can be reached at tracciatti@westmonroepartners.com.

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