As saving money and creating value at the portfolio level continues to be at the forefront of everyone's mind, an increasing number of private equity firms are setting up pooled purchasing plans to give their portfolio companies a leg up. Mergers & Acquisitions convened a special roundtable with some of the pioneers in the space to discuss the benefits and challenges of creating a pooled purchasing program across a private equity portfolio. UnitedHealthcare sponsored the event and the excerpted discussion that follows provides a range of perspectives on what private equity firms with pooled purchasing programs are doing and what they expect to happen with these programs in the near future. Participants included private equity investors, a consultant on performance improvement and a vice president from an insurance company.

Roundtable Participants

Tom Byrne, director, performance improvement consulting services, McGladrey; Roberto Ferranti, vice president portfolio operations, Baird Capital; Danielle Fugazy, contributing editor, M&A (moderator) Michael Groeger, national vice president for private equity, UnitedHealthcare (sponsor); Pam Hendrickson, chief operating officer, The Riverside Company; David Knoch, senior managing director - strategic services, Irving Place Capital

Fugazy (moderator): Each private equity firm here has some sort of pooled purchasing program. How do your programs work?

David Knoch (Irving Place Capital): One of the strategic initiatives we've done over the last nine years is build a stronger operating orientation in our firm. We are a better partner to management today and bring more resources to the table. We are about building capability and scale for companies that can't afford these resources. That's part of our business model, and it's been pretty successful for the past several years. There are things that are common across the portfolio, like insurance, health benefits-indirect purchasing categories; any and all kinds of professional services; treasury and real estate. We have methodically built the capability to leverage common spending and best practices so we can help our companies execute. Our portfolio companies alone don't have scale or buying power. We have methodically built this platform as a way to create opportunities for portfolio companies to save money, amongst other things.

Roberto Ferranti (Baird Capital): We look for opportunities to improve portfolio company performance and leverage the size of the portfolio across a variety of areas and geographies. For example, we have several initiatives with the indirect side of spending. But we also have some experience with direct sourcing. We complement that with our team in Asia that we use for opportunities on a company-by-company basis to source directly from Asian suppliers, often leveraging relationships across the portfolio companies. We are expanding that from China to India and Vietnam, and we are exploring Mexico and Brazil as well, so we have a global perspective.

Pam Hendrickson (The Riverside Company): Our program has existed for the past eight years. We negotiate big contracts for our little companies. We also have a team in China that helps not only sourcing, but also selling into China, which has been a really great opportunity for some of our companies. Our analytic and sourcing team negotiates the big contracts and looks at analytics on companies. We also have something called the "Riverside tool kit," which is consultants that have been vetted by various people in our companies.

Fugazy: Are your portfolio companies mandated to sign up for your programs?

Hendrickson: Our view has always been the programs have to stand on their own sufficiently so every CEO goes: "Well, I'd be an idiot not to save 40 percent on my shipping." Occasionally, we do have a company that won't want to join. Reasons they give for not joining the program are things like: "My brother-in-law is my insurance broker," or "They deliver pizza every Tuesday to our firm." CEOs who are incentivized appropriately on the Ebitda line will very quickly get over that. Most of our programs do save portfolio companies 30 percent to 40 percent. If you can save 30 percent on telephony or on shipping, it's really worth it to do that. But we don't like to pound everybody upside the head.

One exception we may make this year is forcing everybody to at least have some form of check on their benefits because the potential for running afoul of the new Affordable Care Act regulations is very high.

Ferranti: We don't mandate it either. The only thing we mandate is the audit piece because of some compliance issues with our audit firm. We provide a choice of two different providers to the companies. All of our other programs-including shipping, parcel, office supplies and IT-are really common sense for the portfolio company. Companies look at the programs and say: "I am competing above my weight class in a way." We switch them over to our programs and that's a great starting point to get credibility with the portfolio. We are adding value right from the beginning. It goes a long way in establishing a good collaborative partnership with our companies.

Fugazy: Does having this purchasing power make you more likely to get a deal closed?

Hendrickson: Our strategic sourcing team will help the deal team on due diligence by estimating the potential cost savings from our programs and this might result in us being able to submit a higher bid.

Ferranti: We start looking at purchasing efficiencies during due diligence. We commonly use a waterfall that shows the areas where we think the opportunities are going to play during our ownership and a component of that is what we call the "shared-spend program." Depending on the size of the opportunity, that may be a factor when we decide what we will pay.

Fugazy: What are the different areas where it makes sense to participate in pooled purchasing?

Michael Groeger (UnitedHealthcare): When you are talking about these types of purchasing programs, the first one you see and want to look at is the highest expense category. And for the longest time it's been "the unicorn in the room;" that's how one private equity firm put it. You could see it, but you couldn't touch it. And that was the notion of healthcare purchasing from a portfolio standpoint.

However, I think over the years as operational support has become more prevalent, it's become clear that there are ways of doing this. It really depends on the private equity firm imposing some influence. This is clearly the most emotional and territorial issue that you will encounter across pooled spending. And so, often the purchasing professionals will just throw up their hands and say: "I don't even know what to do with the brokers down there. They just muddy it up so bad for us we don't know what to do." Or it gets back to who has got the relationships, fraternity brothers, country club friends, longstanding relationship. It can become very difficult. But with the notion of these purchasing programs out there, everybody is kind of on board now.

The portfolio companies are looking up for solutions. And now that we have moved into an environment where ACA is the law of the land. We're through the elections, the Supreme Court rulings. Now, is the time. And, instead of this bottom-up purchasing environment that we have had for so long in private equity, it's time for a top-down approach. The stage is really set to wrap your arms around it.

Tom Byrne (McGladrey): Healthcare is emotional at the employee level. Years ago, if you got employees off of the Blue Cross Blue Shield high-end plan, and you go to an HMO, employees felt they were getting the shaft. But now what I find is if you explain it right, the younger employees want to buy the HMO because it costs less money. They aren't going to the doctor much. When you explain it, it can really be a win-win. That said, it will be interesting to see how Obamacare plays out because the brightest minds in America can't figure it out.

Hendrickson: Our medical premium across the portfolio is $40 million. Before we negotiate with insurance underwriters, the fees and taxes from ACA will be between 6 percent and 8 percent. That's not factoring in loss ratios or anything, so you are talking around $3.2 million. Now pick any multiple. I used seven, so I just lost $22 million of equity value, and all I did was sit in my office. The point is we have been working really hard on improving the health of our employees across our portfolio to save on medical costs. And it's really worked. The new law may disincent us from continuing these efforts.

Knoch: We are trying to help our companies become better decision-makers on healthcare. We create transparency across the portfolio in how brokers are compensated by line of coverage, which is a very interesting way of making people aware of where the dollars go on one aspect of their spending. We have all of these different data points that we can actually produce for our small to mid-size companies that they've never had before. We help our companies think about conducting annual dependent audits and whether they should be done manually or electronically and whether a company should be fully insured versus self-funded. These are all things that we can do at our level because we have the ability to influence change, collect data and get mind-share of good service providers to help our portfolio companies solve problems.

Fugazy: Do you have providers that you will then recommend?

Knoch: Yes we do. But you know what? In some cases, it doesn't matter. If a human being doesn't want to work with your recommendation, they are not going to make it work. Our point of view is these things work best when they are voluntary.

Fugazy: It must be very frustrating, when you can't get a portfolio company on board with something that will save them money. Ultimately your job is to drive growth and returns to the limited partners.

Knoch: It happens. You can tell the story to the management team and let them make the decision. Sometimes when their performance is great, it's not worth the brain damage on something that might not be strategic in the grand scheme of things. Sometimes when the performance goes a little bit the other way, it presents an opportunity to reintroduce the concept, and they are more willing to listen to it. At the end of the day, if they are aligned with us in the equity, they want to do the right thing. But sometimes it's a timing issue, a personality issue, an economic issue, and you just work through those things at the appropriate time.

Ferranti: When you first acquire a company it's a great time to validate that your program is best in class. It's a great chance to actually revisit your program. It is an evolving thing. We tried healthcare five years ago, and that's one program that did not work for us because once we pulled together all of the universe and population, then we went to the broker and the broker started cherry-picking: "I want that risk profile. I don't want that." And so it kind of destroyed the whole purpose of pooling together from the beginning. I realize the world has changed, and I take note of all the great successes across the industry, so we are probably going to take a second look at that.

Fugazy: But once you start addressing the employees and you start asking them to change the doctors, change the plans that they are used to, how easy or difficult is it to get that acceptance from the portfolio companies?

Groeger: From our perspective, what makes this work for UnitedHealthcare is that we run the largest single national network. Blue Cross is a confederation of a number of different plans, and they're not all unified. We have one national network, which works perfectly with private equity because groups can be anywhere and everywhere. There are different solutions, and we do try to do a lot of up-front work over the portfolio with the private equity firm even before any of this is discussed at the portfolio level. We identify what the plan looks like, what the opportunity is. The notion of throwing a blanket over the whole thing, can be naïve. In terms of changing doctors, this goes back to our national network. It's the largest network in the industry.

Ferranti: We find when we get down to the employee level, that's where the kind of compliance with the program starts to drift a little bit. Travel is an example. We have a program in place where we don't capture the full potential because it's so much easier to go on Expedia or Travelocity, and employees are completely bypassing our leverage. That's lost volume that we could use to negotiate better rates with the hotels, airlines and rental car companies.

Hendrickson: That's why whenever anyone asks me about these programs I always say: "Start with paper clips. Don't start with benefits. No one cares about their paper clips. We started pooling on healthcare seven years ago and our first try was a disaster. Our CEOs screamed. As we looked into what was happening we realized that, at the end the day your claims are your claims, so you can jump around from insurance company to insurance company, but you are never solving the real problem. We had to educate employees about costs. If you go to the emergency room for a sore throat, it's costing somebody $1,500 for you just to walk through the door. And we had to make everybody healthier. Great news: It's working. People's body mass indices are going down, and people's blood pressure is going down in our companies.

Fugazy: How are you driving employees to be healthier?

Hendrickson: You drive people towards consumer-driven plans. Once it's their own money, people behave differently. We get people to fill out the health risk assessment form. If they fill it out, then benefits are a little bit cheaper. If they meet three of five biometrics, then they get a further discount. I liken it to car insurance. If you're an A student, you pay less.

Fugazy: If you went down the line, what is the easiest program to get management to buy into and how do you actually do it? And how quickly can you get companies to convert?

Ferranti: We typically start with office supplies. Implementation is usually very quick, four to five weeks, and acceptance is generally high. Then I would say small parcel is quite priority for us as well-it's a larger spend, a lot more meaningful, and that's more difficult to get acceptance from the portfolio because of the complexity of different products they ship, different areas where they ship, different requirements. It's just more complex, but very easy to recognize and be accepted by the portfolio.

The one that we struggle with a little bit even though the money should be there, is the Maintenance, Repair and Operations (MRO). The decision is typically by the maintenance manager, who doesn't really want to be involved.

Byrne: This can be very localized. Maintenance guys love to just get in the car and go see the guy down the street. They can call them at 9 a.m. if there's a crisis and the part is in by noon. And they like that and it's easier. If you want to buy a machine part that's engineered, you can buy it from China and wait for delivery. But if you are buying tube steel or sheet steel you're going to buy it from the local guy because it's more practical.

Ferranti: Pallets and corrugated are other examples of where local manufacturing relationship is really important because you can't really ship efficiently across the country.

Knoch: When you are meeting with management for the first time and you are explaining the platform of programs that you have available to them, let them decide what's easiest or the best way to do that. It might not be the fact that we think that these three categories make sense because that doesn't matter. It's what he thinks makes sense or she thinks makes sense. So that's the path that we have headed down.

Hendrickson: I also think on the implementation side there is a lot of hand-holding that has to happen. If you are converting someone's telephone system from AT&T to Global Crossing, you need to have great points of escalation within the service provider, so, if something goes wrong, you can solve it quickly.

Knoch: Having the contracts with the service providers is easy. It's how you execute it that matters. How do you get buy-in, how do you develop accountability, how do you make sure that it gets done effectively, and then ultimately generate the results. That's the art of this. It's really about the human touch.

Fugazy: It's probably hard to put a number on it, but how much value is there in these programs?

Knoch: It's meaningful. You get large, double-digit savings by leveraging the family. You get big savings by bringing in a disciplined process. You get big savings by having your private equity sponsor sit at the table with you when you're interfacing with the supply base. We can move the needle on the dial.

Hendrickson: Your goal is to drive Ebitda growth. And so when you look at the rapidity with which some of these programs can drive your Ebitda growth, it's amazing. You're taking down expenses or providing a more efficient process.

Fugazy: How do you manage the relationships with the vendors? When does it make sense to not do this in-house, but rather use an outside firm to negotiate on your portfolio's behalf?

Knoch: I was one of the senior leaders at Alaris, a boutique consulting firm. Being a consultant and selling these kinds of things and concepts to private equity firms is very different than sitting in the chair that I am sitting in today. Our ability to influence change is different. As an owner, I have my personal skin in the game. The portfolio companies don't view me as an outsider. As I am aligned with the deal team, they take it very seriously. Outsourcing this kind of capability to a consulting firm is less than optimal. There are firms that do it very successfully, but we have seen a benefit by having the in-house capability to look and act like a partner; to have a human touch to it.

Byrne: That makes sense, but not all the private equity firms are the size that their firms are so may need some outside help. Not everybody can do what these folks can do in-house.

Hendrickson: That's true and it makes a lot of sense for smaller firms.

Fugazy: What are your feelings on selling through a third-party company versus going right to the private equity firm?

Groeger: We tried initially to work directly with private equity firms. And based on the complexity of healthcare purchasing, it's just not something they do everyday. It's way outside of their scope. Plus, you've got the emotional part of it, and you actually reach the individual employee. So the scope of what is being done here is very different. We made a strategic decision five years ago that we would work through intermediaries going forward.

If the operating professional is ceding that off to that consultant or that distributor all of a sudden, the resonance down at the portfolio company is not what we would want. A lot of the factors that play into human nature start to come into play over what people have been told to do and so forth, so that that becomes a limiting factor. So we get stuck in this nether world of - between working directly with the PE firms and their level of effectiveness in dealing with the portfolio companies or dealing with someone who is very educated in the segment, but can't influence as well.

Fugazy: Is there ever a time when pooled purchasing doesn't work and would that influence you to perhaps not purchase a company?

Ferranti: We see pooled purchasing as a nice addition to our investment thesis. It is never the driving thesis for an investment, so we are not going to pass on the investment opportunity because a program will not apply to the target company. It's an additional part of the path to value for us.

Hendrickson: I think it can go wrong if you have a bad implementation. I would say the first version of our healthcare program did not go well, so that obviously caused us issues between us and our management team. It impacts the level of trust and everything else. You want to make sure that you implement these programs really, really well.

Knoch: Where we have seen things not go well is where someone will take a program, see the benchmarks and they will go right back to their common supplier and ask them to match it. They will match it because they don't want to lose the business. And management will come back to us and tell us now it's not worth it for us to make the change because the cost of switching is too high. Then we have to go back to our partner and say: "Hey, this great benchmark that we have been using is not so great anymore." The end result is not a great dynamic for the viability of the platform long term.

Groeger:The stalking horse issue is one of the biggest challenges that we have as well. And it gets really to the heart of the whole notion of how those purchasing programs are set up. We align ourselves with a PE firm looking for a partnership and we structure our arrangements in such a way that the more business we get, the better pricing gets. So there are instances when we are doing our job and then the local team will take it back to the current vendor, and they'll receive some sort of concession or consideration based on our proposal.

Fugazy: Are more private equity firms trying to participate in pooled purchasing?

Groeger: It is an immature area in the middle market still - especially in the in-house part. There's certainly a legion of procurement people out there really willing to help out. We expect more firms to dip their toe in the water and bring health care purchasing in-house.

Byrne: It brings value to the portfolio company. It increases Ebitda. The LPs are asking a lot more questions around how a PE firm will drive value and they are more selective about investing their money. They want to know how much of the return came from leverage versus operational improvement and these programs could get LPs more comfortable with investment because they drive value.

Groeger: LPs now are looking at the PE firms as more of a partner, not just: "How much did you pay for the company?" But: "What are all of the other goodies that come with this?" PE firms have to market themselves on some level as well.

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