Making technology an asset
When it comes to your IT system, do you know when to fix it, leave it or heave it?
By Rick Bushnell and Adam J. Fein -- Industrial Distribution, 7/1/1999
Is your information technology system an asset or a liability? Will change to the system increase or decrease the value of your company? Conventional wisdom says to get new, big, enterprise computers and use gobs of computer intense e-commerce. But as a business owner, you face a few legitimate questions: When should my company resist the trend to invest "big" and instead make just a few incremental improvements? When should my company leave well enough alone? When should we pitch the old system and make the big investment?We term this challenge the fix it, leave it or heave it question. The large capital expenditures associated with an IT infrastructure reduce cash flow. In theory, this up-front investment brings a financial return through more efficient operations and better information management. On the other hand, there are a number of tried and true technological steps that could boost cash flow and/or reduce operating costs so that the company will show better profits without making major changes to your IT infrastructure.
In this era of consolidation, it turns out that the fix it, leave it or heave it issue has a lot to do with whether you are going to "eat or be eaten," or grow or sell your company. Companies in a growth mode need to ask two questions:
- How friendly is my overall IT strategy, with respect to hardware and software, to integrating acquired businesses?
- Should I consider changing my system and strategy now in order to take advantage of opportunities in the future?
If you are thinking about selling your company within the next five years, you must be able to answer two different, yet critical questions:
- Should we invest in technology to increase the sale value of the company?
- Which technology investments will allow us to command a premium if and when we decide to cash out?
In this article, we provide a framework to help you answer these questions.
Acquisition activity forces decisions
The last 15 years have seen record acquisition activity in distribution, a trend that shows no sign of slowing. For the consolidators, the post-acquisition business integration process determines the nature, scope, and probability of actual value creation from an acquisition. Yet, little is known about the best tactics for integrating acquired companies into new organizations, or how technology influences the financial return to an acquiring company.
As a result, post acquisition integration costs are hurting the performance of some consolidators. Consider the case of an industrial distributor that had rapidly acquired a number of smaller companies. The plan was quite conventional -- use bloated inventory from the acquisitions to flow through a number of leaner branches. Then, consolidate new orders and get big volume discounts. However, they found out that reality was very different, because each acquired company was using different part numbers, computer systems and inventory control software, making it all but impossible to integrate shipping and buying functions.
Unfriendly computer systems, inventory records and incompatible business systems wound up costing this acquirer three times more than initial estimated integration costs. So for two years following the purchase, the profits from the acquired branches went to feed operating expenses, rather than to pay off the purchase price.
System friendliness is not just limited to inventory related issues. Customer data, historical buying data and data mining (the ability to search volumes of information to see trends and create new opportunities), as well as e-commerce capabilities, all can be pluses or minuses on a valuation balance sheet, depending on the degree of difficulty to integrate newly acquired companies.
Although the post-purchase costs of acquisition integration may simply be unknown, we believe that most companies simply do not pay enough attention to the impact of technology on the value of a target company's information assets. As the example above illustrates, the financial return to an acquirer and the price paid to the acquired company are strongly influenced by the level of value-adding technology (or the lack thereof) already at work, and the technological compatibility (or the lack of fit) with other systems.
As a result of post-integration challenges, many distributors are overvalued (or undervalued) because the true cost of business integration is not measured. Companies looking to be acquired may not realize how the quality of their IT systems increase or decrease the sale price of their company.
What to do, and when?
How do you determine when to make major IT investments, when to refine processes, or when to do nothing? If your industry is consolidating and acquisition activity is high, you must first identify your basic strategy. Distributors face three strategic options: get big, get focused, or get out.
If you want to get big and become a consolidator, a major investment in information technology may hurt your business in the short-term. The disruption of automation may throw your business into turmoil and hurt your competitiveness in the market. However, this short-term pain is counterbalanced by increased value from the new system combined with a more solid platform for acquisitions. If you standardize on a well-known large enterprise platform, then your IT infrastructure should be designed, at a minimum, to convert customer records, identify financial situations, and track inventory. Ideally, it would provide for e-business and support the management of orders, inventory, warehouse operations, transportation and finances.
To survive consolidation, many distributors are trying to get focused by retreating to a niche part of the market. Larger distributors, in their quest for efficiencies through standardization, inevitably end up under-performing for certain customers. Smaller, more nimble distributors can exploit the opportunities created by ineffective consolidators or slow-moving large companies. Local distributors can emphasize responsive and personalized service for smaller customers.
Getting focused requires technology that is equal, if not superior to, other systems. Here again, industrial distributors must know how to define, design, develop and deploy technology. Obviously any improvement must have a short enough payback time to help the bottom line. There are some things that can be implemented quickly and the savings will fall to the bottom line. A simple change like using bar code scanners at counter sales can reduce the time counter people spend writing orders and allow them to spend more time performing counter trade, meaning more sales. A real-time order picking and shipping verification system may eliminate shipping errors (making customers happy and saving you time), reduce inventory and increase your turn-and-earn ratio.
Remember, the company that decides to get focused in order to stay healthy always has the option of selling and, of course, buying other companies. Hence, it's wise to keep system compatibility and friendliness as a goal of the IT system.
If you want to get out of distribution, the question is how fast, and how good are company profit and value numbers right now. Think about some of the same things mentioned in the get focused approach. This underscores the importance of planning to sell a company, rather than just letting the sale happen. Some process improvements may begin to pay back in less than one year, but a company still needs another year to report. In this case, the company must be planning at least two years ahead of the selling date.
If the value is not quite what the company might want, you should make an asset and liability evaluation of the IT system from the perspective of a potential buyer. If your company has a relatively new IT system and has been feeding it clean and timely vendor and customer information and inventory records contain up-to-date U.P.C. numbers, the IT system may be an asset.
By taking the perspective of the buyer, it becomes clear that properly prepared data files (even in an older computer system) create hidden value for the consolidator. Effective negotiations force consolidators to pay for this value by recognizing the impact the IT will have on the ease of post-purchase integration.
Alternatively, your IT infrastructure might make integration harder for the buyer, particularly one that aims for a rapid, standardized integration. Many consolidators look for distributors with a solid, loyal customer base, combined with an inefficient, low-tech organization. These targets have invested little in building an information infrastructure. This makes it easier for the consolidator to integrate the acquisition and creates greater opportunities for strategic synergies in the combined organizations. Ironically, an IT investment that makes your business better may simultaneously make you less attractive as an acquisition candidate. Therefore, you should invest in competitive intelligence to learn about the post-acquisition strategies being pursued by the buyer with which you are negotiating. Use the information to get a premium for your company.
There are other scenarios to consider. If your company has an older IT system with "homegrown" part numbers, the system may be a liability to a potential acquirer. In that case, you might want to develop a strategy to at least make the IT system neutral.
We all have been told how the information age gives us new competitive weapons. But we often forget that any weapon can backfire. Merely investing in the latest "weaponry" is not the answer. You must really understand what you can still get out of the old system, because the new may be too expensive or difficult to deploy. The greatest cost factor in the fix it, leave it or heave it question is defining what your company wants to do, and designing a solution around an existing or new system. It is not the cost of the hardware or software anymore.
Finally, you must also appreciate the way in which an IT system can alter the value of your business, both positively and negatively. The financial return to an acquirer and the price paid to the acquired company are strongly influenced by the level of value-adding technology (or the lack of technology) already at work, and the technological compatibility (or the lack of fit) with other systems.
EDITOR'S NOTE: Adam Fein (adam@pembroke-consulting.com) is president of Philadelphia, Pa.-based Pembroke Consulting Inc. Rick Bushnell (rickb@quadii.com) is president of Quad II, a management consulting firm based in Chalfont, Pa.
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