Corporate TreasuryFinancial Supply ChainLetters of Credit/Open AccountCollaborating with Capital – How to Enhance Your Supply Contracts

Collaborating with Capital - How to Enhance Your Supply Contracts

Negotiating Value into Supply Contracts

Imagine if IBM had negotiated a significant equity stake as an integrated element of its initial licensing deal with Microsoft. (IBM in fact negotiated a licence fee as most of us would, but that deal created value for Microsoft beyond their wildest dreams.) Microsoft’s market capitalization today stands around US$294bn and IBM at around US$155bn. Money or the box, IBM took the money and it turns out the box was worth more.

Another example is the collaboration between Compaq, the US-based computer manufacture, now a brand of Hewlett Packard, and Hon Hai, the Taiwanese electronics manufacturer, whose products include PCs for Hewlett Packard and handsets for Nokia. Hon Hai’s early life revolved around manufacturing cables for Compaq. Hon Hai flourished and diversified as Compaq’s business expanded. Hon Hai’s market cap is approaching US$40bn and Compaq is sadly no longer with us. Similarly, Motorola collaborated with Ningbo Bird, now a major competitor to Motorola in China. There are numerous suppliers in China who are now IPO’ing for phenomenal, and perhaps unreal, valuations, built on the back of supply contracts from the west. The list is long and distinguished. I am sure you can think of examples in the companies you work with where your supplier’s valuation has dramatically increased on the back of business you have given them.

Do the Intangibles Count?

When we award supply contracts we invest much more than the price we pay. We invest our reputation, our brand, our quality, our intellectual property, our processes and our capital, human and cash. The price we pay represents the cost of supply, not the value of the business we create. It is like the difference between market capitalization of a company and its book value. We negotiate book value in our supply contracts, not the market cap of the relationship. In Microsoft’s case that implies an eightfold difference (remember this number). The implications are that we are negotiating only a fraction of value in our supply contracts. But do the intangibles count? If there was ever a rhetorical question, that was it. Of course they do.

Recently I discussed this value disparity with the chairman of a telecommunications company. Immediately he gave me an example where a new contract they were awarding would triple the business of a listed supplier. I asked what he thought that would do to the supplier’s share price. It turns out that the question was indeed rhetorical as well. There is no question that the value we create in the deals we do, creates value beyond the price we pay. Yet while that wealth is created by the buyer, it is rarely captured, accessed or accounted for. Why? When was the last time you structured a warrant or option over a supply contract?

Collaboration is Needed to Benefit from Supply Chain Opportunities

So why don’t we structure more of our trade around accessing value beyond the goods that we buy? The answer lies somewhere in segregation of duties and the conflicts that arise within those silos we create to manage them. Within corporations, procurement and treasury are always at war over cash flow or discount. Corporate finance teams are out hunting mega acquisitions. Venture arms are out on the leading edge hunting the latest technologies and innovations. All the skills, but rarely the required communication and collaboration.

Yet gold is made in the supply contracts we award and they tend to be ignored completely as a source of competitive advantage. Not glamorous enough for the corporate finance or venture teams. Too complex for treasury to structure cash flow solutions with banks and link them to both procurement costs and equity holdings. And after all, banks also segregate investment banking and cash management – never the twain shall meet. They pose different priorities, different metrics and different concepts of deal making. And on the rare occasions when they do get together then a bigger boardroom is needed.

Banks too, for all their advice and domain expertise also miss the opportunity. One senior banker with whom I recently spoke told me about a deal where his global bank negotiated a marketing alliance with a dynamic young firm. The alliance was a major breakthrough for the relatively small partner. Undoubtedly the association of the global bank’s brand will help lift their business to a whole new level. When I asked the banker why he didn’t negotiate equity in the company, he stated that the internal bureacuracy made orchestrating such a deal across silos within the bank almost impossible. This represents lost shareholder value.

If we believe in collaboration, why can’t that collaboration extend to valuation? If we believe revenue growth is the major driver of shareholder value, then there is gold we create in our own supply chains. We create it directly. We control the timing, the magnitude and the tenor. The good news is that there is a way we can structure to access value in our supply contracts.

How Can You Enhance Your Supply Contracts?

In one recent example, Competitive Capital worked with a US listed company on a supply contract structured with equity and warrants around aligned goals. The result, our client yielded seven times the value of the supply contract in equity (not quite the Microsoft ratio but close!) while the supplier tripled their valuation in 12 months. That certainly beats 20 cents in the dollar margin on cost of goods sold which was also achieved as par for the course of business.

What made this structure special? Each party benefited through tight alignment to delivering results. Delivering value to their shareholders. Alignment on priorities, alignment on margins and complete alignment in maximizing value in the market. Each party was focused on value rather than cost leading to decisions based on value. A slight but incredibly important realignment. Each party had a stake in the other’s success. That is indeed the spirit and the power of collaboration.

What opportunities lie in your own supply chain? How can you structure to make those contributions sustainable and build your own company’s valuation? Building a collaborative supply chain capital model requires expertise, discipline and perseverance in knocking down or working across silos. A deep and integrated understanding of working capital, cash flow and valuation is pre-requisite to being able to enroll your supply chain into your vision. In some cases, it may require retraining your teams with new skills and supporting them with new performance metrics aligning them to value, not cost. No easy task to be sure. But for the few pioneering companies who have already begun the journey, the reward more than compensates for the effort. After all, isn’t shareholder value our raison d’etre?

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