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Don't Sell That Plant!

June 26, 2008
Guidelines for assessing the manufacturing function in an M&A transaction.

Manufacturing in the M&A Crosshairs

Manufacturing companies involved in a merger may find that they have too many plants or plants in the wrong locations and look to outsourcing as a quick fix. However, outsourcing manufacturing as part of post-merger integration isn't always the best decision. Not only may it fail to deliver cost savings, but a poorly designed outsourcing model can also lead to organizational instability and loss of strategic advantage. In some cases, it may even risk the overall viability of the business.

To Outsource or Not? Two Examples

To avoid these pitfalls, companies should not make a snap decision to outsource, but rather evaluate their business model and create a detailed business case prior to taking action. The following two case studies illustrate how adopting these practices may help reduce risk and increase the overall effectiveness of an M&A deal.

Case 1: Create a valid business case prior to making the outsourcing decision.

A multimillion-dollar telephone equipment company using an outsourced manufacturing model acquired a smaller wireless equipment company with insourced operations. Before the deal closed, executives made the decision to outsource the acquired company's products. This decision was made, however, without careful analysis of the acquired company's product cost structure. Decision makers assumed that outsourcing to Asia would be less expensive than manufacturing in North America.

After the deal, the company worked with the preferred contract manufacturer to develop a cost model. The analysis showed that while many direct costs would be greatly reduced (e.g., wages, material), other indirect costs would only be partially reduced (e.g., IT, legal, facilities, insurance) under a fully outsourced operating model. Some other costs (e.g., travel) would actually increase. The total outsourced cost per unit was only marginally lower than the in-house cost per unit, which did not justify the large set-up costs.

Lessons Learned and Effective Practices

An "outsource everything" model should not come at increased expense to stakeholders. In this case, financial analysis revealed that the significant one-time costs associated with outsourcing did not justify the marginal ongoing savings and should have been evaluated prior to the development of an outsourced operating model.

This case also demonstrates why a phased approach to decision making is preferred-a phased approach provides a more structured framework for using data to evaluate make vs. buy decisions before the deal is done. Figure 1 outlines a phased methodology to navigate the maze of M&A manufacturing decisions.
Figure 1Confirm Strategy. Define the requirements for corporate or business unit level profitability and the associated merger-driven synergies that support those goals. Existing manufacturing capacities in both companies should then be evaluated.
  1. Determine Future State Capacity Needs. These capacity requirements should be driven by evaluations of industry trends, customer demand patterns, competitor actions, and product development planning. Expectations regarding future manufacturing technologies and their anticipated impact on productivity should also be considered.
  2. Analyze Make vs. Buy. Once profitability expectations, cost reduction targets, and capacity requirements are defined, the team should conduct a series of "make versus buy" analyses to determine whether to consolidate plants, invest in new facilities, or outsource existing ones. The total aggregate cost of creating a product and delivering it to the customer should be viewed as the most important component of these analyses. This exercise can help uncover hidden costs that can be a deciding factor when making the decision to consolidate, expand, or outsource.
  3. Execute. After the team reaches a conclusion on the make-versus-buy decision, the execution phase begins. Activities can include selecting plants for consolidation, determining a greenfield site for a new facility, or choosing a contract manufacturing company. Selection activities often range from two to six months depending on the scale of the operations involved. Executing the overall M&A manufacturing strategy often takes between 12 and 24 months from concept to completion.
  4. Monitor. Many companies would benefit from the adoption of new systems and processes to properly monitor the new state of manufacturing. This may include a contract manufacturing scorecard, system touch-points with a new logistics supplier, and various process and information handoffs that were not required in the previous manufacturing environment.

Case 2: Evaluate an M&A manufacturing outsourcing decision based on an integrated process review.

A semiconductor equipment corporation decided to divest a major business unit. As part of this divestiture process, the new company decided to outsource manufacturing and related activities.

The company effectively evaluated the cost model highlighted in the first case, but encountered difficulties when attempting to isolate the manufacturing assembly outsourcing from the outsourcing of related processes.

The newly divested company no longer had the infrastructure to support core activities related to global manufacturing, such as prototyping, new product introductions, logistics management, and trade compliance. The company evaluated each of these processes, created an operating model to support them, and determined the extent to which each of these could be outsourced to an existing contract manufacturing company or whether they should be retained in-house. The project was effective in creating a hybrid model that used some of the manufacturing vendor's capabilities while expanding in-house capabilities in other production-related areas.

Lessons Learned and Effective Practices

This case illustrates that, in a post-merger integration environment, a manufacturing business case may not be enough. Having a new corporate structure dictates the need to evaluate manufacturing as a component in a larger value chain (Figure 2).

Figure 2Conclusion: M&A Due Diligence isn't Just for Finance.

The two cases outlined illustrate both the rationale and the tools required for performing detailed due diligence as part of manufacturing outsourcing decisions before, during, and after an M&A transaction. By developing a sound strategy aligned with corporate objectives and creating a business case prior to decision making, companies can be better equipped to make the right call for insourcing or outsourcing. In the end, the "common sense" decision to divest manufacturing assets as part of an M&A transaction is actually a much more nuanced matter of trade-offs and choices that must be carefully considered in order to achieve lasting value for the stakeholders of each merging entity.

Bill Fink is a manager with the Outsourcing Advisory Services group at Deloitte Consulting LLP. Tim Vadney is a senior manager in the Strategy & Operations service area of Deloitte Consulting LLP.

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