Kamcity Library - Private Equity Independency?

Despite the fact that City opinion indicates that the private equity boom is ‘somewhere near its top’, it is likely that the effect of such takeovers of retailers will continue to impact supplier-customer relationships over the next five years.

Essentially, private equity firms derive value from inefficient firms by restructuring the organisation, selling off assets, reorganising cashflows. Or, they add value to fast growing firms by providing them with cashflow, and then re-float at a higher valuation. In other words, the business is primarily driven by financial KPIs to ensure a high valuation when re-floated. In the process, they become more challenging competitors for non private equity retailers.

Whilst private equity funded customers will obviously require fundamental changes in trade strategy, those retailers traditionally funded by the stockmarket will need to incorporate similar financial KPIs in order to preserve their independence. This means that suppliers will also need to change their approach to traditionally funded customers in order to optimise trade investment and partnerships. In practice, this means that a traditional customer will also want to maximise its return on capital. Realistically this means achieving an average ROCE of 15%, net margins of 5%, stock rotation of 20+ per annum and sales per sq.ft. of £1,000+ per annum. It will buy on an average gross margin of 25%, with an average GMROII of 500%.

A major benefit for suppliers will be that a stockmarket funded company will continue to operate in very transparent conditions, in that the results will be readily available in its annual and interim accounts. This means that by gaining experience in helping the traditional customer to achieve its financial KPIs, the resulting skills will help in managing private equity customers, albeit operating in more opaque circumstances. Given these fundamental changes in the market, suppliers will need to revisit the partnership criteria used in determining whether to invest, maintain or divest of each of their traditional customers. In terms of potential market share, the customer will have to operate in a more competitive environment, short-term, thereby changing its life-cycle stage and thus require re-balancing of a supplier’s customer portfolio.

Whilst the customer’s corporate culture is unlikely to change fundamentally in the short-term, it is likely that the increased focus upon financial performance will require the supplier to reassess strategic alignment in terms of new definitions of short, medium and long-term investment for both parties. Consumer-shopper match will also change because of new competitive pressures, requiring re-allocation of trade funding in order to compensate for shopper switching amongst the customer base. In terms of investment appeal, traditional customers will adopt the private equity approach of favouring investments that show an immediate impact on the bottom line, thereby ruling out investments promising deferred rewards. However, in return for delivering immediate bottom line improvement, the supplier will be in a better position to negotiate a high degree of customer compliance.

Finally, because of these fundamental shifts in trade partnership measures, it is likely that the supplier’s relative appeal to the customer will change, when compared with other suppliers. This means that the whole customer portfolio, a mixture of private equity and traditionally funded retailers, will have to be rebalanced in relation to the supplier’s objectives and growth expectations. Given this highly transparent level of financial interdependence, and operating, out of necessity, at the financial limits, it is crucial that the supplier base this reassessment of the trade partnership upon a robust customer profitability analysis system. Otherwise a supplier’s risk-seeking profile evolves into recklessness…with only one loser.

Incidentally, should a traditionally funded retailer ignore the new need for financial KPIs, then such apathy can increase the possibility of their becoming part of the private equity lunch-menu….

For KamTips on 'Traditionally Funded Customer as a Financial Partner' see Namnews – July 2007

Date article published: 07/2007

Latest Additions