Increasing conflict between Russia and Ukraine, labor shortages, and geopolitical concerns in China have driven up fuel costs, created new logistics restrictions, and continue to add to the supply chain disruptions many industries are facing.
Despite many freight markets having minimal exposure to Russia, Ukraine, and China, indirect factors continue to plague the supply chain, from aerospace restrictions and lingering COVID bottlenecks to heightened risks in raw material shortages and labor implications.
The growing interference in the supply chain is trickling down to private equity firms, many of which are reconsidering investment decisions to leverage new technology aiming to develop more efficient and innovative processes in the logistical process.
Understanding the Current Situation for Private Equity Firms
According to Henry Mcvey of KKR, a global investment firm, “the theoretical high-water mark for globalization came in 2008, when global merchandise exports as a percentage of global gross domestic product reached nearly 27%. By 2021, that had dropped to 19%.” (McVey, KKR).
There is no doubt that the global supply chain is presenting obvious weaknesses. Global shutdowns, economic turmoil, and record labor resignations are presenting challenges.
Traditionally, private equity firms look for countries with low labor and costs to move manufacturing portfolio companies to. We’ve seen shifts from Mexico, then to China and South Asia. In the post-pandemic world, private equity firms may be struggling to find portfolio companies successfully navigating these newfound costs and delays.
As a result, we see offshore trends reverting back to domestic shipping with local suppliers. Private equity firms are now considering both domestic and international portfolio companies.
Optimizing the Supply Chain for Value Creation
Private equity firms may also be rethinking post-acquisition strategies. Long-term supply chain resilience and reconstructed procedures are at the forefront of considerations, suggesting that private equity firms consider outside factors rather than the bottom-line number.
Raw material volatility and labor shortages may also be directly impacting effective supply chain management and value creation. In fact, a report by Deloitte addressed four key considerations that supply chain leaders should analyze throughout the M&A process, including:
- Reworking operating models and organizational structures
- Maximizing talent, technology, and practices found in each supply chain
- Creating standardized processes and systems
- Making strategic investments that scale the supply chain and help expand the business
Value creation for private equity firms is expanding to analyze the impact of acquisitions on supply chain resilience, hedging against risks, increasing operational performance, and adding to competitiveness.
Conducting Thorough Supply Chain Due Diligence
Private equity firms should be expanding due diligence procedures to understand the relationships and dependence on Ukraine, Russia, China, and other countries with growing economic and political turmoil.
Dealmakers should also analyze the impact of physical transportation, including restrictions through certain areas. For example, many companies are reporting increased difficulty navigating the Silk Road, with HDI’s risk engineer, Markus Ebest, describing that companies “will certainly have to expect organizational, technical and infrastructural challenges” (HDI).
Can prices be passed down to consumers? What is the true cost of supply chain disruptions on the bottom line? These are questions that private equity firms consider before adding a company to the portfolio.
We have seen a shift in investor sentiment toward supply chain risks when assessing the validity of a deal. What once was a major setback can now be overcome by horizontal and vertical scalability purchases. However, in cases with major risks associated with the supply chain, mergers and acquisitions may be placed on pause.
Additionally, certain private equity firms are capitalizing on global supply chain disruptions by purchasing companies that improve processes, such as logistics technology companies. The difficulty with this type of acquisition is projecting the long-term performance and profit levels, which may be done with effective due diligence.
Considering the Trade-Off Between Efficiency and Resilience
Private equity firms are now rethinking their approach to supply chains at the portfolio level. Two of the strategies that are gaining popularity are lean management and moving toward domestic carriers.
Maximizing both efficiency and resilience requires strategic policies on two fronts: proactive and reactive. Taking a proactive approach often involves private equity firms looking into different portfolio companies on the supply chain, from domestic and international shipping companies to technology-based logistic companies and intermediaries.
Reactive policies should also be in place to ensure resilience. This could be steps to mitigate the financial impact of supply chain disruptions or have a plan in place to handle unforeseen delays.
Recent economic and political events have led to rising global supply chain risk, suggesting private equity firms find ways to adapt and overcome new challenges. The inability to adapt can not only put firms at financial risk, but may also decrease long-term success.
Deloitte. “Supply chain’s role in M&A: Achieving value creation through supply chain.” Deloitte, 2017, https://www2.deloitte.com/content/dam/Deloitte/us/Documents/mergers-acqisitions/us-ma-supply-chains-role-in-m-and-a-achieving-value-creation-through-supply-chain.pdf. Accessed 28 Nov 2022.
HDI. “New transport options on the Silk Road.” HDI, 18 Mar 2022, https://www.hdi.global/infocenter/insights/2020/silk-road/. Accessed 28 Nov 2022.
McVey, Henry. “State of Play.” KKR 24 Mar 2022, https://www.kkr.com/global-perspectives/publications/state-of-play. Accessed 28 Nov 2022.