Globalisation moves downmarket

January 2013 | EXPERT BRIEFING | BOARDROOM INTELLIGENCE

financierworldwide.com

Despite the large amount of press devoted to the issue of globalisation in the past 20 years, most lower middle market companies (companies with sales below $100m) have, until recently, felt themselves to be insulated from sweeping changes in the global competitive landscape. In the short term that may have been an accurate assessment, but the long term impact of that view, and the complacency that it bred, has come to haunt many of these companies. While their larger competitors sought to adjust to the new competitive landscape by investing in new processes and technologies, developing more and higher value-add products and services, pursuing joint ventures, and finding ways to expand both domestically and internationally, too many companies in the lower middle market contented themselves with their market niches and congratulated themselves on their good luck. But now change has come to those companies, and they are not prepared.

Trends challenging smaller companies

New processes and technologies. Increasing complexity in the market demands increasing organisational complexity. Deployment of technology and implementation of process improvements aimed at maximising the value of that technology are both essential for companies seeking to wring efficiency out of their operations. Companies that lack robust Enterprise Resource Planning (ERP) and Customer Relationship Management (CRM) systems are at a severe disadvantage in terms of both driving cost savings in their operations through improved efficiency and identifying opportunities for increased sales opportunities.

Product development. The diffusion of global productive capacity has resulted in downward pressure on low value-add products. Savvy competitors have responded by devoting themselves to an up-tempo product development cycle. The key to maintaining, let alone increasing, gross margins for many companies lies in offering customers a steady stream of product innovation.

Growing reach of private equity. From its roots as a disruptive outside force in the 1980s and early 1990s, private equity has matured to become a part of the business landscape. As private equity has become an entrenched force in developed economies, the model has shifted in ways that have had and will continue to have a profound impact on smaller companies. Private equity firms have increasingly looked to the middle market for transaction opportunities. In recent years the push toward add-on acquisitions, in which an existing private equity owned company (the ‘platform’ company) pursues multiple acquisitions to supplement its own product and service offerings, has given private equity a reach that potentially extends to nearly every market niche, especially in developed countries.

International sourcing. As sources of production have proliferated globally, savvy companies have begun to reassess their sourcing policies. However, many experts have noted that a narrow focus on cost savings, especially when driven by labour cost differentials, can often obscure the full cost of adding complexity to a supply chain. Smaller organisations are far behind the curve on this trend, and run the risk of failing to learn from the mistakes of their larger brethren.

Growth opportunities. With US growth slow and growth rates throughout the eurozone ranging from uninspiring to worrisome, any company lacking an international expansion focus is essentially ceding the most promising route to growth.

Challenges for advisers and capital providers

The advisory and investor ecosystems must adjust to the challenges facing the lower middle market.

Advisers. The challenge to the advisory community will be to adjust to the highly dynamic environment that is becoming the new normal for lower middle market companies. Increasingly, periods of calm will be the exception rather than the rule, as pricing pressure, cost pressure, a need to upgrade both processes and technologically, and private equity funded incursions into all market niches, force companies to pursue growth through acquisitions or to sell.

Capital providers. The capital provider community will be tasked with picking the likely winners and losers as the competitive forces outlined above force consolidation. Winners will consist of companies occupying defensible niches that could be acquirers themselves and well-managed companies that represent attractive acquisition candidates. Losers will be those companies facing declining sales and eroding equity value. This later group will be one that capital providers will seek to reduce their exposure to, in some cases likely speeding the process of consolidation.

Conclusion

In developed economies across the world, a perfect storm of globalisation and competition has descended on lower middle market companies, and, to a very large extent, these companies are not ready. Advisers and capital providers will increasingly find themselves involved in the process of helping the winners and losers adjust as we enter this new chapter in the global economic story of creative destruction.

David Johnson is a partner at ACM Partners. He can be contacted on +1 (312) 505 7238 or by email: david@acm-partners.com.

David Johnson

ACM Partners