By Jim Tompkins, CEO, Tompkins Associates
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Jim:
Welcome back to the Global Supply Chain podcast series on Mergers and Acquisitions. This is Jim Tompkins the President and CEO of Tompkins Associates and Tompkins International.
Our last podcast focused on the trends and global M&A as we emerge from the Great Recession and move into the Great Comeback. I can tell you from a personal point of view, this is really occurring.
Last week at Tompkins Associates we had ten different M&A activities that we were involved with, so a lot is happening. I have invited Dr. Kim Woodard, to come back again to extend the comments he made last time on trends in M&A activity in the BRIC countries - Brazil, Russia, India, and China.
We ran out of time just as Kim was getting into some interesting issues that touch on cross-border operational integration. You will recall that Kim is Vice President of Technomic Asia, a division of Tompkins based in Shanghai and that he is a China hand with some 40 years of experience in the region as well as an experienced M&A deal-maker. Welcome back, Kim. For the first time ever, a second part of a podcast.
Let's take a step back from the macro M&A trends that we discussed last time. Tompkins is all about operations integration - the entire supply chain from plan, BUY, MAKE, MOVE, STORE, SELL, and RETURN. These are our areas of core competence and the way we help our clients achieve competitive advantage.
Kim - Can you give us your perspectives on M&A in China and the other emerging economies from an operational perspective? Multinationals are extending their reach in the BRIC countries in two basic ways – organic growth of existing operations and acquisition of local companies. Doesn’t this create an increasingly complex and challenging operating environment as they "bolt on" local companies that have completely independent operating standards and practices? What are your insights how this is working?
Kim:
Thanks Jim. It's a pleasure to be back and glad to see you started me off with a nice simple multiple-choice question here.
Actually, you have put your finger on a major shift in the operations of multinational companies in large emerging markets like China. Ten or fifteen years ago, China was basically virgin territory for most multinational manufacturing companies. They were looking for local joint ventures or building up their own grass-roots manufacturing operations primarily to serve the domestic market and to get around import restrictions and high tariffs - in short they were "In China for China." Supply chains and distribution channels were built around the needs and products of individual plants and were relatively simple. Naturally this leads to a lot of duplications of processes and decreased efficiency.
Fast forward to today and the situation has changed dramatically. China's entry into the World Trade Organization ten years ago lowered tariffs and other trade barriers. Company operations grew dramatically as the domestic market exploded in size. One client of mine in the bearing business went from one small joint venture and $30 million a year in sales to six large plants in multiple locations and half a billion dollars in sales within a ten-year period.
Furthermore, this company has now integrated its China operations with global manufacturing, distribution, and supply chain operations. It now exports half of the bearings produced in China to global markets and imports half of the bearings sold in China from plants around the world. So from being "In China for China," we are now moving toward "In China for China, for Asia-Pacific, and for global markets." Multinationals increasingly view their China operations as just one part of the global operating platform.
And as we discussed last time, China is just the largest and fastest growing BRIC country. We find a lot of clients that are not only developing their China and India operations in parallel, but also working from the outset to plan and execute on operations that are integrated to the extent permitted by the legal and regulatory environment in the two countries. And I think you would find the same pattern in Brazil and Russia as well.
The operational issues posed by this change are indeed very challenging. Every multinational with significant operations in China now has dedicated materials handling, sourcing, and supply chain organizations embedded in their central China management structures and closely linked with similar departments at headquarters and around the world. This is a whole new operating environment and it is one well suited to the expertise that Tompkins brings to the table.
Jim:
I love it! Integration of complex supply chains is where Tompkins lives and what we deliver. But let me bring you back to the M&A environment again. How can multi-billion dollar companies cope with the integration of companies in China or Brazil that have maybe $50 or $100 million a year in sales and with very backward distribution operations and supply chains? From where I sit, this looks an order of magnitude more difficult than integration of two similarly structured companies in the U.S. or Europe - already a tough process that frequently fails. How are your M&A clients in China handling this challenge?
Kim:
Good question. I will give you the short answer first and then dig down a bit.
The short answer is that integration of relatively small acquisitions in emerging countries, say under $100 million in transaction value, is usually done very slowly, particularly at the front end. This is because the new parent company wants to preserve the cost advantage and the existing sales channels and customer base of the local company. There is almost always a fear of burdening the local acquisition with the high costs and bureaucratic burden of the parent. Companies are afraid to Tyco-ize or Wal-mart-ize the local company, thereby destroying its original value. One way to avoid doing this is to simply let the local acquisition operate on its own for a few years, with low level of integration from parent.
Some systems, such as financial reporting, IT, and higher environmental standards, have to be imposed at the outset. The sales operation usually poses a problem, since the parent is likely to have its own sales channels and needs to at least coordinate the sales operations of the local affiliate to avoid confusing customers. Furthermore, local sales practices may not conform to the business standards imposed by the Foreign Corrupt Practices Act and may need to be cleaned up right away to avoid non-compliance with U.S. law. But as a general rule, the multinational tries to hold onto local management and allows a relatively independent operation for the first three to five years. This rule only applies to relatively small acquisitions. The larger the acquired operation, the more swiftly the target company must be integrated with all aspects of the global operation.
Jim:
I understand Kim, it is like that old saying that I don't know if I even like all that much - if it ain't broke, don't fix it and if it is broke, don't acquire it. Makes sense.
But this still leaves the longer term issue. If the parent fails to integrate key operations, such as distribution and supply chain management that will build in long-term inefficiencies and higher costs and will also fail to capture potential synergies in the supply chain.
Kim:
That's right. The independence of the acquired company should only be allowed to stand for the first 3-5 years. Then deeper integration is needed to capture distribution and supply chain synergies and to secure the customer base.
Let me give you a specific example. I helped a $1.5 billion U.S. telecom equipment company acquire a local $50 million company in Shenzhen a couple of years ago. The management of the Shenzhen company was left independent and the local company actually took over parts of the sales operation of the parent in China. The deal structure included a three-year earn-out period that gave the original owners significant incentives to stay in the operation and to help it succeed. The transition went exceptionally well, key telecom customers were retained, sales revenue and profits exceeded expectations, and the deal became a bright spot in what was otherwise a dismal year because of the global recession.
But there will be a second phase of the integration that will need to be executed in another year or two. One of the key logics for the acquisition is that the Shenzhen company sits in the middle of the Pearl River Basin area, which has thousands of local suppliers of electronic components. My client wants to capture this supply base and to integrate it not only with other manufacturing operations in China, but also with their global supply chain. So ultimately the supply chain management of the parent and the subsidiary must be integrated to capture synergies and lower cost, but it just takes time to get there.
Jim:
Kim, thank you very much I certainly agree with what you are saying about the importance of the supply chain with the parent and the subsidiary. This topic is so important it is the topic of the sixth portion of this podcast, Supply Chain Integration. Without this integration we will not capture the synergy and the real return on investment of the acquisition in the first place. So this is critically important. Kim, I see we are nearing the end of this podcast, I would like for you to summarize by giving us a few key takeaways of the global M&A operations issues that we need to get our heads around.
Kim:
OK, Jim. Here we go on the take-aways. These cover the last podcast and this one on global M&A.
1. Global M&A took a big hit in 2009 as a result of the Great Recession and the financial crisis as multinational companies locked down their capital budgets to preserve cash and the strength of their balance sheets. In the BRIC countries - Brazil, Russia, India, and China, inbound acquisitions by multinationals took a big dip last year. But the M&A market in these countries is rebounding this year, with old projects being re-started and new projects moving into the deal pipeline. We expect a very robust level of global M&A activity in 2010 to 2011.
2. Recovering volumes of cross-border investment and M&A deals will lead to increased emphasis on operations integration in the emerging markets - particularly on integration of outside-the plant-operations, such as distribution operations, network optimization, materials sourcing, and supply chain management. Companies are now coordinating their investments and manufacturing platforms across multiple emerging markets like India and China and are no longer simply focused on relatively small and isolated in-country operations.
3. Multiple acquisitions of relatively small local companies in different geographies will present special challenges in terms of operational integration. Many multinationals choose to leave the local managements of these acquired companies relatively independent for the first three to five years, initially integrating only key functions such as financial reporting. But there will need to be a second round of operational integration of these companies after the first few years to ensure that available synergies cost savings are achieved and that the acquired company contributes fully to the regional and global growth of the parent.
That's it for the take-aways, Jim. Thanks for the opportunity to visit with your podcast audience.
Jim:
Thank you Kim. I am really excited about the Technomic Asia M&A practice and we hope to invite you back at a future time to talk more to our Tompkins audience about M&A. Well that ends our 2-part podcast with Dr. Kim Woodard. Thank you so much Kim, glad you were with us. The last and final portion of this series will be with Genet Tyndall on the importance of SC Integration, following M&A. I really look forward to having Gene with us. Thanks so much, talk to you real soon.
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