Three key strategies to deploy in a demerger

WORDS: Vikas Tyagi

What is the role of procurement in a demerger? Is it to manage operational risks, reduce costs or both?

We all know the power of volume consolidation and economies of scale, and how these levers can be used to deliver improved procurement outcomes by securing more favourable commercial terms with the supply base. However, in a demerger or carveout situation the scenario is quite the opposite.

Volumes purchased are typically smaller due to a focus on preparing the demerging business(es) for separation. This means far less leverage when negotiating with the supply base. But when handled right, carveouts can still be an opportunity for procurement to reduce and optimize costs while mitigating operational risks. 

Demergers and carveouts require existing supplier contracts to be updated in line with the reduced volume needs of the demerged business(es). There may be situations where suppliers will look to charge higher unit pricing for products and services to make up for smaller volumes. This requires procurement to step up and proactively play a role in minimizing the commercial impact. The following three strategies could work well in such scenarios.

1. Do your homework

Ahead of negotiations with suppliers, review the rights to assign, rights to use (in divestiture scenarios) and other similar language in contractual documentation, confirming your understanding with the legal department. Also, work with the business to identify alternative products and services that can be sourced in the near future and use this as a key lever where difficult supplier conversations are likely. Always plan strategically for these conversations, involving senior business stakeholders and legal where appropriate, and ensuring the messaging is geared beyond price negotiations and focused on partnerships.

Communicating a ‘big picture’ view to major suppliers can be helpful, particularly where there is clarity over the target operating model. This gives suppliers an indication of potential future engagement and can help smooth commercial discussions in the immediate future.

2. Ask the right questions

Demergers and carveouts can present a considerable opportunity to right-size contractual arrangements and further optimize the commercial impact. The key to delivering reduced costs – even when volumes are diminishing – is to ask the business a set of clear and relevant questions in terms of its procurement requirements. These could include:

• Has the business taken the time to consider whether the product and/or service is likely to be needed in the near future?
• Is the product/service in question a ‘need’ or is it a ‘want’? Needs and wants should be reviewed robustly to ensure appropriate setting of future requirements.
• Has the total cost of ownership been considered rigorously enough to ensure that only required elements of the product and/or service are purchased, e.g. you may wish to pay for the product but the cost of support/maintenance may no longer be needed by the business.
• Can product and/or service providers be consolidated as part of contractual changes (e.g. consolidation of more than one purchase/service from a supplier but on different contracts/terms and through different vendor entities)?
• Have product/service substitutions been considered, particularly where high-cost products/services can be replaced by lower-cost options?
• Are all aspects of a product/service being fully utilized? Can the usage be dialled up where spend has already been committed and dialled down in other areas, (e.g. in the case of different modules of a software suite)?
• Can new contracts be signed with preferential terms without any exclusivity and with no minimum spend commitment?

Getting clear answers to these key questions can help deploy a set of levers that focus on actual cost reduction.

3. Manage operational risks

Supplier contracts and other relevant commercial information should be centrally filed and easy to access. Yet when demergers are announced, procurement teams often find themselves caught short, unaware of what contracts they have, the key terms, and both the operational and commercial risks that exist because of the transaction scenario.

To minimize operational risks, it’s important to consider the key procurement challenges and how to mitigate them ahead of any announcement. This can be done by first developing a clear understanding of all contractual agreements across the supply base, gathering any amendments or supplementary agreements ahead of a potential demerger.

Starting early on IT and telecoms (including software) is critical. This category of spend can result in major issues if the current contractual situation is not understood well enough to plan an approach. Working with IT to ensure a good understanding of the asset usage of both hardware and software is equally important.

Planning ahead to get the input needed from legal teams and ensuring all necessary reviews are completed in sufficient time for contract renegotiations is recommended. Finally, discuss and agree supplier implementation requirements with the operations team well in advance of any demerger. It’s important to work hand in hand with operations throughout the entire process to ensure things run smoothly.

Final thoughts

The role of procurement goes well beyond operational risk management in corporate restructuring, mergers and carveout programs. In carveouts specifically, timely consideration of the above levers and subsequently defining a well-thought-out approach is key. This can give businesses a strong negotiating position with suppliers, enabling them to right-size their procurement requirements and reduce costs – even when volumes might be smaller.

This article was originally published in Supply Management.