Supply and demand – supply chain M&A

July 2024  |  COVER STORY | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

July 2024 Issue

The connected nature of the global economy makes robust supply chains essential to many companies’ operations. But in recent years, these supply chains have faced a variety of geopolitical and macroeconomic challenges.

Following the coronavirus (COVID-19) crisis, other issues including persistent inflation, conflict in Ukraine and Gaza, as well as turmoil in key shipping lanes have disrupted global trade routes, resulting in supply bottlenecks, higher transportation costs and increased prices for goods.

Geopolitical tensions make international supply chains, already intricate systems spanning continents, even more complex. Wars threaten the flow of grain, oil and consumer goods. Climate change and mass migration affect trade lanes from the Panama Canal to the US-Mexico border.

Such uncertainty caused freight market volumes and consumer spending to fall. A drop in service rates squeezed profit margins.

With no end in sight, sourcing and distributing goods remains fraught. Should these factors continue to impact global trade flows, companies may be forced to redraw the trade maps on which have come to rely.

Near or far

Many organisations have already sought to mitigate supply chain risk by onshoring or nearshoring some of their operations. This involves relocating key processes to their home country or to a country nearby. It is a reversal of the offshoring and outsourcing trend seen in previous decades.

Onshoring or nearshoring is growing in popularity with global trade flows in flux. Against the backdrop of tensions between the US and China, many importers are turning away from the world’s chief supplier of goods to alternative countries such as Vietnam, India and Mexico. Indeed, China is no longer the US’s largest trading partner, being surpassed by Mexico in 2023.

According to CBRE, the main sectors driving nearshoring in Mexico are automotive (mainly involving tier 2 and tier 3 suppliers) in the northeast of the country and in the Bajio region, and the electronics and appliances industry in Mexico’s west and northwest. The general manufacturing, chemicals and packaging industries are also active.

Due to delays, difficulties securing materials and exponentially rising costs, companies are now looking to gain greater control over their supply chains.

Onshoring or nearshoring strategies can reduce transportation and environmental expenses and give companies more control over project management. Bringing supply closer to the source of demand can dramatically reduce lead and fulfilment times, making supply chains quicker, more efficient and less vulnerable to uncertainties. Other possible benefits include access to a cost-effective workforce and a wider talent pool, and fewer cultural or time zone complications.

Buyers are targeting acquisitions of companies or assets located domestically or in neighbouring countries, potentially disposing of international subsidiaries or assets to help fund such deals. According to an NTT Data survey, 68 percent of shippers feel that supply chains are now overly global and require rebalancing toward a more local and regional approach. A perceived overreliance on global supply chains has contributed to undersupply of certain products and contributed to the cost of living crisis. As shipping prices rose, many organisations passed increases on to consumers.

Buy and build

As an alternative, or in addition, to onshoring or nearshoring, companies are also turning to M&A as a solution to build supply chain resilience.

Vertical dealmaking – a process by which certain aspects of a supply chain, such as manufacturing of a component or sourcing a raw material, are brought together under common ownership – is increasingly popular. According to a recent Deloitte survey, 23 percent of chief financial officers expect an increase in vertical integration over the coming years.

Companies that previously relied on outsourcing to obtain critical materials, parts or components for final assembly are pursuing vertical deals to help avoid issues such as raw materials shortages or escalating supplier costs. From a sustainability perspective, the trend could also have a positive impact on reducing waste in supply chains.

There are, however, competition issues around vertical dealmaking. Regulators have raised concerns that some manufacturers may lose access to acquired suppliers, which in turn may lead to consumers paying higher prices.

In the US and EU, regulators have taken a more aggressive stance on vertical transactions in recent years, scrutinising deals they would previously have approved and examining whether deals are likely to stifle competitive dynamics. With jurisdictions adopting a tougher approach, acquirers will need to plan for regulatory review when negotiating merger agreements.

More generally, M&A can also be deployed to acquire technology solutions for optimisation and resilience. In recent years, technology and digitalisation have been leveraged to deliver efficiencies and cost savings. Emerging technologies provide insights into aspects of the supply chain such as inventory management and forecasting, identifying potential problems and alerting companies to developing trends. According to Research and Markets, the global digital logistics market, with an estimated value of around $22bn in 2024, is projected to reach over $81bn by 2029.

Due diligence and risk analysis

Due diligence is an integral part of any M&A transaction. Today, companies must go beyond just financial considerations to take into account many more facets of a target company, including its supply chain.

Gathering data on a target’s supply chain enables a buyer to determine its efficiency and cost-effectiveness. By identifying potential problems and taking steps to address them, costs may be reduced, and profits increased.

During the process, companies will want to answer a number of key questions. How are relationships within the supply chain organised and maintained? What risks and vulnerabilities exist within the supply chain? How well do the current systems and processes in the supply chain integrate with each other? In what ways does the supply chain support sustainability and social responsibility objectives? What opportunities exist for future growth and scalability of combined supply chains?

Such questions can uncover potential compliance issues or ethical lapses, avoiding potential financial, legal and reputational damage down the line. Buyers can assess whether suppliers and subcontractors are adhering to laws and ethical standards, as well as taking measures to reduce environmental impacts and labour exploitation. Conducting supply chain due diligence puts acquirers in good stead to deliver long-term sustainability.

In Europe, such considerations are important following implementation of the EU Supply Chain Due Diligence Directive. The new law is designed to ensure that companies comply with ethical and environmental standards when conducting business. Under the Directive, companies are required to conduct due diligence on their supply chains, including assessing the risks and opportunities associated with suppliers and subcontractors. In addition to addressing any identified risks, they must report certain issues to the European Commission in a timely manner.

Another crucial aspect of supply chain due diligence concerns environmental, social and governance (ESG). New laws and regulations in connection with ESG factors are putting companies under pressure to improve their performance and report on progress. As such, acquirers need to carry out ESG-related due diligence on prospective targets, to assess potential risks.

The EU Corporate Sustainability Due Diligence Directive (CS3D), for example, came into force in early 2024, and aims to enhance protection of environmental and human rights in the EU and globally. The due diligence obligations contained within the directive include a broad range of specific rights and prohibitions.

Companies will be obliged to identify, assess, prevent, mitigate and remedy negative impacts. This relates not only to the upstream supply chain including indirect suppliers, but also partially to the downstream side, such as distribution, transport, storage and recycling. The provisional agreement specifies supply chain activities by making an exception for dual use products and weapons (export control) and exempting sale.

Approximately 13,000 EU companies and an additional 4000 additional non-EU companies may fall within its scope as the CS3D becomes binding over the years ahead.

Synergies and integration

Unlocking synergies in a supply chain is another key driver of M&A deals. It may be possible to create related value that is greater than the sum of the individual parts.

According to Deloitte, supply chain executives are under pressure to deliver on four fronts. First, to identify, capture and deliver deal-related synergies. Second, to invest in operations to support end-state business growth objectives. Third, to integrate legacy supply chains with minimal impacts to customers, partners and employees. And lastly, to make critical decisions quickly to keep pace with transaction deadlines. “While supply chain synergy targets vary by industry, Deloitte experience shows that the supply chain typically is responsible for half of announced deal synergies,” adds Deloitte.

Acquirers will need to adopt a holistic approach that takes in areas such as cultural alignment, operational integration and strategic alignment. Prioritising operational and strategic synergies is important. According to McKinsey, 70 percent of executives believe that operational synergies are the most significant contributors to overall deal value. Technology integration, process optimisation, talent retention, market research and analysis, product portfolio optimisation, and brand amalgamation all contribute to a successful deal.

Other aspects will need to addressed by supply chain leaders during the M&A process. Among the most crucial, as noted by Deloitte, are: (i) redefining the supply chain operating model and organisational structure; (ii) leveraging the combined talent, technology and leading practices of each supply chain; (iii) standardising processes, systems, policies and performance metrics; and (iv) making investments to build and scale the supply chain to support the expanded business.

Additionally, according to a report by Deloitte, 94 percent of executives believe that cultural integration is crucial to the overall success of M&A transactions. If the parties to a deal are aligned on values, norms and beliefs, greater synergy realisation can be achieved. To that end, companies should embark upon a programme of cultural due diligence during the deal phase. Understanding the cultural compatibility of the companies means problems can be identified and addressed. Additionally, transparent communication and an effective change management programme are needed to develop a unified culture.

While each transaction is unique and brings its own challenges and opportunities, companies should have a playbook that sets out predetermined roles and responsibilities at senior level, to ensure that as the transaction process advances, supply chain planning and optimisation is not overlooked.

Once initial integration activities are completed, the combined company will want to focus on post-deal transformation and growth. According to Deloitte: “Conducting a rigorous ‘stare and compare’ analysis across both legacy companies’ supply chain processes may yield significant opportunities that should be captured before too much change is instituted.” It adds that, when executing a phased transformation plan, collaborating across the new organisation is critical. By harnessing the best of both supply chains, the combined company can reduce risk and capture value.

Going forward, supply chain resilience is likely to remain a key factor driving M&A in certain sectors. One example is the retail space, where companies may look to reinforce supply chains by onboarding technologies.

Tech effect

As companies push to transform their supply chains digitally, analysts expect 2024 will see an upswing in M&A activity driven by supply chain technologies. According to CB Insights, among the major factors driving dealmaking in emerging technologies in 2024 is companies’ need to improve supply chain resiliency and agility.

Companies will utilise acquisitions to boost performance and gain greater end-to-end insight into their supply chains. Four of the key areas in which they can do this, according to Gartner, are labour, intelligence, security and edge.

From a labour perspective, companies can address rising costs and labour shortages by supplementing, enhancing or replacing humans with technology and automation that can perform tasks independently. They can also use artificial intelligence (AI) and machine learning to make better, faster and more informed decisions. From a security point of view, addressing cyber risks associated with digital and cyber-physical systems within supply chain partners today is vital.

The integration of AI and big data is ushering in a new era of efficiency and adaptability for supply chains. AI can assist with, for example, predictive analytics and automating warehouses. According to McKinsey, AI has helped businesses improve service levels by 65 percent, inventory levels by 35 percent and logistics costs by 15 percent.

Geopolitical tension, armed conflicts, economic uncertainty, rising cyber threats and extreme weather events put a strain on supply chains. Efforts to increase resilience are, in turn, gathering pace.

Companies will continue to explore ways to increase the resilience of their supply chains. Macroeconomic instability, increased costs, shortages of goods and trade route chokepoints are compelling them to seek workarounds.

In the quest to develop durable, agile supply chains that can withstand myriad threats and challenges, strategic dealmaking can help mitigate disruption. M&A offers opportunities to steady the ship and develop competitive advantages.

© Financier Worldwide

BY

Richard Summerfield