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What is the Proficiency Index?
There are perhaps 700 office supply dealers world-wide with annual sales in excess of $10M. Approximately 500 of these operate in the US/European markets where the global players are established. The Proficiency Index analysis covers at least half of these leading dealers, most of whom  participate regularly in measuring their operating performance across the 6 dimensions.

Best Practice and top performances are updated at least half yearly.
Check out the regular dealer case studies in Proficiency Profiles and Top Performers.
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Make roll-ups real

Lessons from recent history

31 Aug 08

Background:
Nineties and Naughties

The acquisitions binge of the '90s turned into the value trough of naughties. Here's how a vacuumed company tried to build value then..

Take a highly fragmented industry, like used-car sales, funeral homes, office supplies, air-conditioning services, veterinary care, or laboratory diagnostics. Buy up dozens, maybe hundreds, of owner-operated businesses. Create an entity that can reap economies of scale, build regional or national brands, leverage best practices across all aspects of marketing and operations, and hire more potent managers than the small businesses could previously afford.

It's called a "strategic rollup." The formula has seemed like an attractive business proposition—and Wall Street has embraced it enthusiastically.

But for each successful rollup like Sysco Corporation, the food-distribution giant, or Quest Diagnostics Inc., which operates medical-testing laboratories, dozens of failures litter the landscape.

In fact, close to half of all rollups that we studied have lost 50% or more of their market capitalization since June 1998. Particularly striking is that many rollups were rewarded handsomely by the stock market during their high-growth, early stages of development—until they reached roughly $500 million in revenues. At this level, investors began to probe deeper, ask tougher questions, and demand better performance.

Consider the dismal results from six leading rollups of the last few years—Waste Management Inc., AutoNation Inc., the funeral-home companies Service Corporation International and Stewart Enterprises Inc., and U.S. Office Products Company and its rival Corporate Express Inc. After significantly outperforming the S&P 500 for two strong years (1995 to 1996), these six rollups came crashing down.

Are strategic roll-ups
a flawed vehicle?
Wall Street certainly doesn't think so; after all, investors have poured more than $30 billion of capital into rollups or funds intent on finding industries to consolidate. Nor do we. Our analysis clearly indicates that the problem is not the concept but the execution.

The starting point is recognizing that a rollup is much more than arbitraging assets. Success rides on understanding how to create, capture, and retain value—each step of the way. While many have gone wrong, rollups can be done right. And even stumbling rollups can regain their footing on a prosperous path.

Wheel of Fortune
Rollups, as we use the term, emerged in the mid-1990s as one form of the many waves of consolidation washing over the globe. Rollups differ from conventional merger-and-acquisition activity in three distinct ways.

First, rollups occur in highly fragmented industries, usually service-or-distribution-related, but occasionally in manufacturing. As a result, consolidation involves not a handful of mergers and acquisitions, but dozens, or sometimes hundreds.

Second, the companies acquired are generally owner-operators rather than large, publicly owned companies. This makes integration much more complicated, because people accustomed to seat-of-the-pants decision-making and complete control are suddenly required to play on a team, with corporate instead of personal goals in the forefront. Additional complications arise because the many small businesses use diverse accounting systems and technology.

The third way in which rollups differ from conventional merger-and-acquisition activity is that their strategy is not to gain incremental advantage but to reinvent an industry, creating an entity with a fundamentally superior value proposition.

The bet underlying a rollup is that it can reduce costs and drive growth to create enormous value. In fact, kindling organic growth is particularly important as the pace of acquisitions begins its inevitable decline. Rollups take on considerable costs: premiums paid for acquisitions, debt, high-powered management teams. To make good on that investment, the entity must grow. When all goes well, we find a cycle of value creation that takes on a life of its own. (See Exhibit 2, right)

As acquisitions are made, value is created from a series of concurrent post-merger integrations, each focused on forging a bigger and more competitive entity from many fragmented individual companies. The value created is shared with the customers (through more attractive pricing or higher quality of service) and employees (through better benefits or incentives). This results in accelerated organic growth driven by a superior value proposition. The market rewards this kind of growth with a higher P/E ratio, which creates the currency for more acquisitions.

Tales of Misfortune
Sounds simple enough, doesn't it? So what can account for so many failures? Our experience shows it's the inability of a rollup to kick-start the wheel of fortune. Contemplate, for a moment, Waste Management's saga. In 1998, USA Waste Services Inc., an up-and-comer in the solid-waste industry, merged with Waste Management, a faltering leader.

Waste Management's share value roared from below $30 to a peak of about $55 per share in mid-1998, when the merger was finalized and the combined company assumed the Waste Management name.

Its 1998 annual report assured shareholders, "We have met the challenges head on, moving swiftly to unify operations and take full advantage of the potential synergies. We have addressed operational issues on every front—consolidating routes and reducing transportation routes, streamlining field operations and facilities, standardizing systems and procedures, and eliminating duplication of administrative and managerial functions."

But little more than a year later, in December 1999, Duff & Phelps Credit Rating Company, while reviewing Waste Management's debt, noted "lingering systems issues" and "the loss of customers through systems and performance difficulties" after the consolidation with USA Waste. At the time, Waste Management's shares were trading below $20 per share, and had been doing so for months.

Or consider Corporate Express, a major distributor of commercial office supply products. Between 1995 and 1998, the distributor acquired more than 200 companies and assumed huge amounts of debt. Despite many widely publicized restructuring initiatives, Corporate Express failed to transform itself and climb out from under its debt. By September 1999, it had lost nearly $2 billion in shareholder value. Shortly thereafter, it was acquired by Buhrmann NV, the Dutch parent company of BT Office Products International.

Right Stages, Wrong Turns
In general, successful rollups must navigate through three distinct, but overlapping, stages of development. Charting the course requires a superior vision, a strong management team, and the right applied know-how.

Stage 1: Create an acquisition engine. The concept of radically restructuring an industry's economics through consolidation requires the ability to identify, negotiate with, and acquire dozens and dozens of companies.

Usually, the first couple of deals are the most crucial; they establish credibility and become the flywheel that drives the rollup forward. A rollup team must have skilled negotiators who can woo owner-operators but, at the same time, not burden the rollup with promises it can't keep, or commitments that will handicap the rollup as it evolves.

The team must also have the financial, legal, and management skills to make several acquisitions a month. U.S. Office Products (ex-CEO Jon Ledecky pic right), for example, made close to 250 acquisitions in less than three years—almost two a week. But a rollup concentrates its management strength in merger-and-acquisition skills at its own peril. The initial team also must have in place skilled management ready to transform those acquisitions.

Stage 2: Compete as an institution. The ability to integrate many acquisitions into a single operating company—and the knowledge of when to do this—are the primary determinants of whether a rollup will reach its promised financial and market performance. The key is to alter the modus operandi of the acquired companies, ensuring that they operate not as a loose confederation but rather as a large and cohesive institution. The changes required to cut costs and ignite growth are often huge, spanning all aspects of the business—from management and control to sales and operations. And the most successful rollups execute this critical stage with measured speed, precision, and certainty. 

 A rollup that fails to achieve these changes swiftly and accurately is left with higher costs and an unwieldy debt burden—and without the powerful growth engine it needs to flourish.

Stage 3: Achieve market leadership. The few companies that make it through Stage 2 are admirably positioned. They begin to redefine the rules of competition and reach attractive levels of profitability.

In the vast majority of rollups we've examined, the problems center on Stage 2. Too often, issues are not adequately anticipated, and the resources and personnel needed to address them are not put into place—a process that needs to begin shortly after Stage 1 begins.

Getting it Right
Navigating through these pitfalls is the key to creating value in Stage 2. Specifically  there are 4 critical building blocks and two key enablers of successful rollups.

1.   The organizational structure must be recast as a single entity, with different sets of responsibilities and reporting structures. Further, if value is to be captured from the increase in scale that a rollup brings, systematic sharing and deployment of expertise across the organization is essential. Continuing to operate as a loose confederation of companies (often typified by a geographic structure) undercuts the rollup's ability to extract value.

2.  Organizational change alone is not sufficient. Fundamental change to the operating model is essential, too. That means consolidation of facilities, institutional purchasing, best practices deployed among the sales force, and so on. Achieving compliance with institutional programs is extremely difficult unless it is supported by changes in human resources policies and incentives, and unless they are buttressed by information systems and tools.

3.  New financial management systems, including a new budgeting process, a new set of financial controls, comprehensive forecasting methods, and enhanced investor relations, must be put in place.

4.   Rollups must redefine the basis of competition. Even if a management team can capture the benefits of its newfound scale, it must still determine how to leverage this position in the market.

A rollup should not tolerate the loss of customers in the integration process. Rather, its strategy should be to increase its share through organic growth—growth predicated upon a superior value proposition incorporating geographic coverage, cost position, superior customer management, or consistency of service.

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