Operational Due Diligence- The Intuitional Aspects

Operational Due Diligence- The Intuitional Aspects

Are you a Private Equity or a Venture Capital firm that has finalized the asset with a huge manufacturing base? Then read on….

Valuing a factory or a manufacturing company can be tricky. Number oriented investment bankers are more comfortable with the valuation derived from the financial models. All the assets like land, factories, machineries, inventories, vehicles etc. are taken into account with assumptions on depreciation to arrive at a value that a manufacturing based asset deserves.

There is one thing that often gets overlooked in the financial models. That is the potential for factory to save costs or improving productivity in future. Assessing this has significant element of experience and intuition. It can have an impact on the final COGS and thus improve the bottom-line of the overall organization. An improved bottom-line that is possible in future will have a bearing on the current valuation. It also decides if the asset managers will be able to derive the value that they plan from the asset in the future.

I will detail a few tools here, that can give an experienced operations personnel, a quick and dirty guide to indicate the improvements that are possible in the operations of a manufacturing company or a factory

Productivity Improvements Studies

DILO: DILO stands for “Day in the Life Of”. It has been used for years now by productivity improvement consultants. DILO is shadowing a personnel for a whole shift/day to understand nature of all activities performed by him, and whether they are value adding or not. DILO is performed over the activities of first level supervisor in the plant. It’s not done for the people at the top and it’s not done for people at the lowest rung too. First supervisory level DILO gives a firsthand idea about the cultural DNA of the organization. It also helps zeroing on the productivity improvements that is possible. A 20% productivity improvement using improved systems is not exactly unheard of.

Management Control Systems: An effective Management Control System study charts out flow of information in the organization and the actions that are being taken on the same. Production planning processes, production control processes and production reporting processes are taken into account. All KPIs/KRAs and review mechanisms are studied too. This study should be able to show gaps in the processes and improvements possible. This can be repeated for functions of Maintenance, Quality Control, Supply Chain, R&D or any other function that has an important bearing on the final output.

 

Pit-stop studies: A pit stop study is conducted to see if the flow of material, men and information happen as they happen during a pit-stop in F1 racing. It also records all the bottlenecks for not achieving the pit stop level efficiencies. Analysis of these bottlenecks give a fair idea about the improvements possible

Bottleneck Study: Identifying a clear line of value addition itself is a task in multiple industries, but if processes are visibility and logically connected, a bottleneck study can be done to find out the bottleneck process or a bottleneck machine. Once identified it’s clear that any improvement that is done on the bottleneck process/machine improves the productivity of the whole line. We need to study the bottleneck machines/processes in further details to find out downtimes and reasons for the same. More avoidable the reasons are, more chances of improvements. A bottleneck process improvement has been able to show 10% improvements in throughput even across process-wise mature plants.

Process Maps: A simple flow of material and information exposes the gaps in processes. Material waiting for information or material waiting for other material or machines or men, all cause delays. As per the established principles of Toyota Production System and lean methodology, wastes need to be identified. Once identified, it needs to be ascertained, if these wastes are avoidable. Again, more avoidable the reasons, more chances of improvements.

Quality Processes: Reduction in quality rejected items directly adds to the throughput. Finding out the effectiveness of quality systems can point towards improvements possible due to reduction in quality rejects.

5S and other housekeeping systems: It makes the workplace clutter free. Absence or presence of these systems point towards the current processes maturity and thus improvements possible.

Cost Optimization Studies

Material Cost: Material costs most often are the highest cost bucket for a factory. There is some raw material fed at the beginning of the production line and there is output in terms of finished product at the other end. All the material that is lost in between is the dollars lost. In process industries, this is also referred as material yield. Finding out the potential to reduce this waste is guaranteed to give future direct bottom-line benefits.

Inventory Cost: In some industry cost of inventory is huge. If inventory turns are not monitored carefully, it leads to working capital being tied up in inventory. Finding out if A, B, C classifications are there and if there are inventory standards for each classification can be a starting point. In case there are standards, a quick audit of some A class materials will show potential of releasing stuck working capital back to P&L.

Procurement Costs: A quick look at procurement processes show if there is some value that can be derived from tighter procurement standards. Few things that can be looked at include, how contracts are finalized, presence of penalty clauses in contracts, contracts negotiations process, RFQ process, low cost country sourcing potential, supply chain cost reduction possibilities, mass discounts and vendor rationalization possibilities. A tighter procurement process has known to produce 10% savings in the spends related to material.

All these studies will also need to be supported by number crunching exercises. It all depends on the extent and quality of data available in the factory.

A dipstick study can be concluded in 2-3 weeks’ time for a plant that produces around 200-1000 Crore worth of stock by a team of 3-4 people. This exercise gives an input to valuation of the plant and the company. It also acts as the road-map for the management in case the asset gets acquired.

Prabhash Choudhary, CEO, Magistral Consulting.

Magistral (www.magistralconsulting.com) is a leading consulting research and analytics firm that helps PE/VC firms globally in performing operational due diligence. Author can be reached at prabhash.choudhary@magistralconsulting.com for queries.