2. Coming from years in the private equity industry, primarily on the buy-side, at ShopFlow
Solutions we know that industrial companies that have implemented LEAN programs are
more valuable than those who do not, usually significantly so.
There are a number of reasons this is the case, and we’d like to discuss a couple very
important ones here. As always, I look forward to the opportunity to talk with you and share
some of my own experiences in how you can make your business more valuable over time…
Going back to as late as the early 2000s, private equity firms were able to negotiate
favorable terms because business owners and organizations were less sophisticated about
valuations, as this was prior to the wealth of information now available to them online.
There were also fewer competitors, as the industry was still in its earlier stages of
development and expansion. But here in 2016, these advantages have shifted to the
target companies instead. These same private equity firms are no longer getting the same
deals they once did.
And this has led many LEAN-thinking investors to spend a lot more time investigating the
day-to-day operating practices of an organization before entering into any sort of
agreements, partnerships or acquisitions.
There are many thousands of small to mid-sized companies out there who are privately-
held and will eventually investigate selling their business.
As part of the due diligence and valuation of those companies, it’s not difficult to make
the case for higher worth for those companies with LEAN-type principles in place. And
knowledgeable business owners are really
starting to take notice of the huge potential
advantages they can generate with enhanced
productivity programs and initiatives, not just
from the standpoint of higher revenues now, but
also higher valuations for their companies when
it comes time to sell their business as well.
One clear reason is a major shift in focus from growth to current profitability taking place
throughout the business world right now, which is also the focus of LEAN – finding ways to
save capital and maximize resources to streamline the operations you have right now -
producing for your current, existing customer base.
The outspoken Bill Gurley, general partner at Benchmark Capital and an astute, well-
respected analyst on the buy-side of private equity, has never been one to sugarcoat his
thoughts and opinions. He was particularly blunt at a 2015 Wall St Journal WSJDLive
conference when he stated that the valuations of privately-held companies are “fake.”
FROM GROWTH….TO PROFITABILITY $$
3. Gurley has been one of the leading voices
sounding caution about the overheated state of
the tech startup market and the need to return
to solid business fundamentals.
In other words, aggressive focus on ‘offense’ is
being replaced by playing great ‘defense’ with
these companies and in the business world as a
whole, again the forte of LEAN and similar
enhanced-productivity programs.
This would be a 180 degree turn from recent
years. ‘Growth, at all costs’ has been the mantra
since the early 2010s as an unprecedented
amount of investment has flooded into private
companies – creating a large segment of
businesses valued at $1 billion and beyond.
Difficult times ensued in 2001 related to the
dot.com bubble and debt market problems,
and the financial crisis of 2008 shook the markets
all around the world once again. But it didn’t
take long before private equity purchases
began to accelerate once again following that
recovery.
And that relative ease of access to cash can
explain why fresh, ambitious organizations have
been ever eager to lavish more money on
marketing and sales than they’ve generated in
actual revenue.
Gurley sees this as a hindrance to the market,
not a positive influence. When money is hard to
raise, he said, innovators can still find funding for
their great ideas. “In this market, they can raise
a ton of money, but so can a lot of [less
capable] competitors that wouldn’t be in
business otherwise,” he told MIT Tech Review.
Executives have been incentivized to focus on
building market share, even as steep operating
losses continue to mount. But the shift has begun
towards the more traditional focus on current
profitability.
Growth has and always will be a prized metric. A
good analogy would be a comparison to wins in
for your local pro sports team. That’s what fans
care about - what’s your record, how many wins
you have. As rudimentary as it may sound, that’s
typically all that Wall Street (and thus, PE firms)
cares about as well - growth. But that thought
process and resulting philosophy are changing.
One need look not further than Uber for the
reason(s) why. Uber's estimated market
valuation is insanely high (between $40 billion
and $50 billion by various estimates), exceeding
the valuation of established airlines and car-
rental companies. This is driven by confidence in
Uber and accepting its staggering expectations
of growth. However, the sheer size of the
backing is going to make it difficult for Uber to
deliver long term.
The fuel for this expansion has been ever-
growing sales and marketing budgets. Another
poster company of this strategy is the cloud
software business Box.
Box went public in January 2016, and has said
publicly that it doesn’t expect to become
profitable until 2018.
That’s quite a long time to wait for profits.
And of course even then they are based solely
upon expectations, certainly not guaranteed.
Though not a manufacturer themselves, Box
depends directly as do all tech companies on
the multitude of manufacturers who build all of
the hardware and infrastructures needed to
create these incredibly sophisticated networks
which support their technology.
Thus their own fortunes are tied directly to the
success, or failure, of the many tech companies
that are operating today as if the potential
payoff tomorrow (or next week, or year) is
assured, and thus explosive growth is the only
metric that matters.
An August tweet said “We may be
nearing the end of a cycle where
growth is valued more than
profitability. When capital feels
unlimited, you don’t worry about
what you get for what you spend.
That’s beginning to change.”
4. And the same dependence on future
revenues, often times on very extended time
horizons, based on massive upfront expense in
sales and marketing is certainly not specific to
one field or industry, but a philosophy which
has taken hold in a vast array of companies.
A primary problem here is that the much
analyzed ‘burn rate’ of their cash on hand
and other liquid assets is often times
unsustainable. If there is a market downturn or
a tightening up of private investment dollars
this becomes even more so.
Box and many similar companies could easily
find themselves in a serious cash crunch (or
worse) in either of these scenarios, and there
will certainly be businesses that have made the
wrong bet and will simply run out of capital
before they can reach the (in their case,
unattainable) Golden Age of Profitability.
A disproportionate amount of capital is being
raised and then going straight into sales and
marketing, along with all the other intangibles
that lead to a sale. These businesses are
operating with the sole objective of telling the
story and building awareness, in the endless
search for the next new customer.
Customer acquisition is critical to any business,
but at some point a higher ratio of the capital
raised needs to be applied to actually growing
the profitability of the customer base which
has already been established.
And when capital seems unlimited, you don’t
need to worry about what you get for what
you spend, as long as you are gaining any
type of marginal gain. But the size of this
margin isn’t a primary concern when
companies are flush with cash to make the
substantial investments required to buy
customers up front.
This can lead to a dynamic of a fiscally-
irresponsible allocation of revenues. The era of
operational thinking based upon the concept
of limitless capital and less concern for analysis
of reasonable returns on sales and marketing
spending is on its last leg.
Companies have essentially been playing the
“long-game” for quite some time, being willing
to absorb substantial - but what they consider
to be short-term - losses with the expectation
of banking big revenues at some point down
the road.
They’ve been betting the cost of acquiring
new customers now will have a handsome pay
off in the future, leading to annual recurring
revenue.
Companies are continually seeking loyalty
from their customers of course, striving for
“stickiness” with the hopes of upselling other
products and services once the relationship
has been forged. This is obviously a sound
philosophy. But the prevailing thought of
overpaying for a Year One customer, looking
towards where they hope that customer might
be in Year 2, 3 and beyond is changing.
Certainly not everyone can win with everyone
playing the same game, but the opportunities
in the marketplace are genuine for many
companies, so the strategy makes sense on
paper.
The primary worry is that all of these high, ever-
growing valuations exist on paper alone. If or
when there is a market downturn these
companies will suddenly be facing a much
different world. The free
ENGAGED CUSTOMERS
5. spending done to acquire customers is
going to come under more intense scrutiny
as a strategy for these business executives.
Many believe that this is going to create a
greater emphasis on accountability,
forcing companies to show expected
return on investment for these acquisitions
in greater detail.
In the case of a downturn, we at ShopFlow
Solutions think it’s going to be amplified.
With limited resources and constraints,
companies will be focusing everything on
driving its livelihood – which is revenue.
This plays directly in favor of enhanced
productivity manufacturing initiatives like
LEAN and 5S.
Instead of the belief in consistent,
uninterrupted growth which many
marketing plans are built upon, growth
through customer base expansion should
be seen in its proper cyclical form.
Continual improvement in your
manufacturing environment however is not
cyclical, but rather something your
business can address indefinitely.
When too many manual interventions and
variations are present, the problem is not
just one of cutting out non-value-added
activity, but also the value-subtracting
activity caused by errors that are often
repeated every day.
In addition, implementing lean
manufacturing mandates the need for
better balance and faster flow of material
through production. In most cases, the
company will need to reconfigure its
manufacturing processes from large lot,
functionally-oriented methods to more
flexible, quick changeover smaller lot
methods for fast response and higher
throughput.
Remember, not just labor and inventory
costs are saved by higher throughput and
reduced cycle time – customers are more
satisfied, and that’s where the money is.
There are many variables for private equity
firms to consider before acquisitions or
partnerships, such as overall
competitiveness and outlook for the
industry, and proprietary technologies the
target may possess. And new customer
acquisition strategies and their results will
always be crucial of course.
However, for a LEAN-oriented investor,
there are many other questions they will
take into account before coming to any
determination related to valuation.
They seek to evaluate not only the current
manufacturing performance of the
company, but also how many
opportunities there can be for future
improvement. They take time to review
how much waste or inefficiency exists
within the business currently, and how
much can this be improved upon, and in
what timeframe.
This is where many middle-market
manufacturing and distribution companies
can really shine, if they have the correct
best practices in place prior to any
investment decisions made by outsiders.
Sometimes easily justifiable capital
investment is required, but in many cases
substantial improvements in flexibility and
cycle time reduction can be achieved
with current equipment.
REVENUE, ANYONE?
6. There’s a maxim that’s been used in
aviation for years, “If it looks like it can fly, it
probably can. If it doesn't, it probably
won't.”
This relates well to the first benefit of a LEAN
program in regards to the valuation of your
business. When seen in your shop or
manufacturing floor, it could be best
summed up by stating:
When potential investors and evaluators
walk through the manufacturing floor of a
candidate company, a very clean and
well-organized shop can’t help but
automatically shape their opinions of the
manufacturing operation positively right off
the hop. This is basic human nature.
And knowing that a highly-capable team
and executive leadership is already in
place can pay huge dividends once it
becomes time to analyze your business
and its potential worth.
Marketing teaches us that most purchases,
and most decisions made it general, are
first motivated by emotion, and then logic
is used to justify them. Even some of the
most astute, financially-driven individuals
are not immune to this principle.
In fact, some of the worst investment
decisions ever made were clearly
influenced by this philosophy.
This fact, as stated here, is by in no means
meant to relate to your own business
specifically. In working together, our goal
of course is to help you create the most
efficient and streamlined manufacturing
operation possible, generating the highest
revenues for your company as well.
But this truth can explain in some ways how
personal opinions can play a crucial role in
determining the valuation of your business.
What may seem as small factors of
consideration can lead to significant
variations on how your company is valued
by PE investors.
Your company’s P/E ratio, the tried and
true method of valuation based on your
current share relative to your per-share
earnings is always going to be crucial. And
this instructs suitors greatly when making
their investment decisions.
However, as with any other metric, the
price-earnings ratio comes with important
limitations. Investors may be led to believe
that there is a single metric to provide
complete insight into an investment
decision, which is virtually never the case.
Of course LEAN manufacturing principles
should improve your P/E ratio significantly
when correctly implemented.
But the evidence of strong leadership
which is displayed by the successful
application of waste reduction methods
like LEAN is also highly sought by investors.
It points towards a reduced need for
significant hands-on involvement in what
they can view as a complex process in the
future to increase the company’s worth.
When our customers need help to
determine what the best choices should
be regarding their waste reduction
strategies, we can work as their LEAN
manufacturing consultant to make the
“What Looks Best,
Probably Works Best”
7. process much simpler than they might assume,
based on our many years of expertise.
Investors want to know that a
successful management team
has already been at the helm
leading up to the present point.
This manufacturing environment,
paired with solid KPI’s and metrics
in place, clearly displays an effective,
pro-active management team.
This is something that investors desire now more
than ever, given that private equity firms are
holding on to portfolio companies for more
extended periods than before. This situation
creates the potential need for longer-term
oversight and management of the business.
Buyers certainly have their own strategies for
leveraging the unique technologies and other
competitive manufacturing advantages that a
company possesses when it comes to their
investments. This has become a critical
acquisition strategy for many individual large
tech companies in addition to PE firms.
Purchasing smaller businesses that possess an
newly-developed technology, or an existing
one they’re particularly adept at utilizing, is a
growing trend.
Advantageous manufacturing techniques,
distribution networks, customer base- pairing all
of these with their own existing product and
service offerings – have created tremendous
opportunities for these major tech players.
Generating huge valuations for their current
business owners, too.
When these entities know they don’t have to
start fresh with LEAN or similar waste reduction
programs to increase efficiency and thus
revenues, this can definitely result in larger
values placed on your company.
Many LEAN consulting companies address the
PE industry specifically due to the added value
brought to bear when the PE firm employs
LEAN in their due diligence pre-acquisition and
post-acquisition plans.
Which means working in partnership with us
here at ShopFlow Solutions you can avoid the
trap of being seen as a business which relies
solely on growth as your main driver to
generate increased revenue.
Research shows that a company could make
a one-time investment equal to ½ of one
employee’s annual wages and impact
profitability many times over. This type of
investment in your facility can provide the
highest ROI impact your can find anywhere,
well before the thought of selling your business
even enters your mind!
“The days of spending $3 to get $1 is going to
end,” concluded Gurley.“We’re getting to where
the CMO isn’t just blindly signing checks for
marketing initiatives and instead asks:‘What is
the top line impact?’ And then the CFO asks:
‘What is the bottom line impact?’We’re going to
see a readjustment and recalibration of growth
expectations as a result.”
AHH….SUCCESS!
If a candidate business has a clean, well-
organized and flowing manufacturing
floor, with the right KPI’s and metrics in
place, the more aggressive the valuation
of the company right off the hop.
Through my own extensive experience, I
know that many PE firms will publicize the
fact they have partners with operating
experience, to work with portfolio
management teams to increase value
by improving operating performance vs.
financial engineering.
8. Implementing time-tested LEAN philosophies in your manufacturing facility
saves you time and money, plain and simple.
And we’d like to help you get your shop or manufacturing floor running as
efficiently – and as profitably – as possible utilizing LEAN within your
organization.
The products we sell at ShopFlow Solutions are all designed to make your
workplace the most productive environment possible, while it continually
improves over time.
Our heavy-duty, industrial grade products stand up to the harshest working
environments, and because we supply directly to OEM and end-users, you
get higher quality products than what other pay for lesser alternatives.
Visit us online (www.shopflowsolutions.com) or call today at (800) 274-4123,
and let us share the wealth of information our company has learned over
the years helping organizations just like yours.
Brad Stack – Owner, ShopFlow Solutions
