Private equity investors are finding that they can create tens of millions of dollars in value by addressing an oft-undermanaged (and unglamorous) cost item: transportation spending.
There are three important sources of transportation cost reductions:
- Renegotiate. The most obvious source is renegotiating transportation contracts in light of recent rate declines.
- Cost-Management Software. Additional savings can be achieved by using advanced cost-management tools in the negotiation process.
- Negotiate Collectively. Private equity funds can derive additional savings by negotiating transportation costs for their portfolios collectively, instead of company by company.
Shortly before the recession, fuel prices exploded, driving up transportation costs. However, the more recent drop in economic activity has produced excess capacity that has driven transportation costs back down. Truck, rail and ocean carriers are all reducing rates to increase fleet utilization. The rate declines span transportation modes, temperature states, full truckload and less-than-full truckload and parcel. Surprisingly, many businesses have not aggressively renegotiated their transportation contracts. We find that these businesses have the opportunity to reduce their transportation spend by 5% to 12%, with the opportunity for some companies being 20% or more.
Many companies that have renegotiated rates did so by employing a traditional bid process, which in essence is a margin squeeze on a small set of carriers. This approach tends to produce less in savings than approaches that leverage powerful decision-making software. These emerging tools allow more carriers to selectively compete for those lanes where they can maintain their margins. Lanes that are undesirable to one carrier may be efficiency enhancing to another (the transportation version of one man’s trash is another’s treasure).
Private equity funds can amplify the power of these tools by negotiating transportation costs for the entire portfolio as one set of contracts. Carriers are not focused on consolidating transportation within a fund’s portfolio, but across the carrier’s existing base of business. Thus, the portfolio companies can be in different industries, serve different geographic markets and be shipping from different areas of the country. With more lanes to choose from, carriers can develop more profitable scenarios for themselves and thus offer lower costs to the portfolio. The combination of using the emerging tools and negotiating as a portfolio can increase savings by an additional 5% or more.
The resulting value creation is substantial. Consider a portfolio of 24 companies with aggregate sales of $2.5 billion and transportation costs of $62 million. These middle-market companies traditionally negotiated their contracts individually, none with any significant bargaining power or sophistication. Going to market collectively and leveraging the emerging tools described earlier, the portfolio reduced transportation costs by about $7 million. The payback on the effort was less than two months. Applying appropriate multiples to the increased cash flows, the value created exceeded $40 million.
Kurt Salmon, a supply chain leader for more than 70 years, has tremendous experience negotiating transportation costs and possesses leading-edge technologies. Our proven expertise allows us to base our fees on the savings achieved by our clients. We’d be happy to share our perspectives with you.
1 December 2009