Michael Collins 2020-07-30 02:11:40
Pragmatic Improvements
The Decision for How to Source IGUs Should be Unemotional
Most complex solutions require analyses on multiple levels to ensure they are successful. Otherwise, the changes put in place will address various short-term aspects of a challenging situation but will fall short as long-term solutions.
Over the past several months, we have come to recognize that manufacturing workers should be distanced from each other to prevent the spread of COVID-19. This conflicts with certain fundamental lean principles, such as arranging workers in a tight hub and spoke configuration around the components used in manufacturing. Meanwhile, doubling or tripling the number of these arrangements might succeed in getting workers six feet apart but could also result in the loss of lean manufacturing efficiencies. Carried indefinitely into the future, solutions that reduce efficiency would result in less profitable businesses that would command lower valuations in the market. The intersection of lower efficiency and suboptimal utilization of space could find a company seeking capital to support an expansion when its financial results make it difficult to attract capital.
Instead, it is critical to explore options that achieve spacing in other ways–including automation.
Other Applications
The same type of standards apply when companies make decisions on issues apart from COVID-19. Elsewhere in this issue, [DWM]'s editors explore whether a company should outsource or manufacture its own insulating glass units (IGUs). Even when the final answer indicates that insourcing makes sense, it is a good idea to run an alternate or perfect storm scenario. This would include situations where revenues drop and it takes longer to achieve optimal efficiency at manufacturing the components in-house. Acquirers who operate plants with in-house IGU manufacturing, in-house profile extrusion or similar capabilities often find themselves in the position of analyzing a company that lacks those capabilities. The natural tendency is to assume that those needs can be met in-house going forward, thus capturing margins currently paid to the outsourced provider. That's a tempting solution, in particular, because it could result in buying a company at one EBITDA level and being able to immediately bring it to a higher level by producing those components in the buyer's existing facility. Over the long term, those capabilities could be grafted onto the acquired business.
The challenge with this is that companies often become emotionally invested in an in-house approach, as those capabilities come to be viewed as part of a company's autonomy. Typically, when a company being analyzed already has in-house production, a prospective buyer of that company makes an unemotional assessment of those capabilities by comparing the in-house cost of components plus any associated manufacturing difficulties, to the use of workers and manufacturing space, plus maintenance expenses and other capital being consumed. These are then compared with the pricing available through outsourced suppliers. In many cases, the determination is made that buying from a capable outsourced supplier would be more efficient and could free up badly needed manufacturing space.
Perhaps we can blame Adam Smith ("The Father of Capitalism") and his work on the benefits of specialization, but the decision to bring the production of an outsourced component in-house is not to be taken lightly.
Michael Collins is an investment banker and a partner in Building Industry Advisors. He specializes in mergers and acquisitions in the door and window industry.
©Key Communications. View All Articles.