The Future of Operations Due Diligence

by Terry Burton | Blog

A quick and inexpensive look at your organization’s operating model in greater detail identifies new opportunities for improvement worth millions of dollars in EBITDA.

What is the best way to improve M&A performance? Before we provide the answer, let’s step back and look objectively at the current state due diligence practices.  Traditionally, organizations do a thorough job on the strategic or commercial, financial, and legal/regulatory due diligence activities.  These are very detailed analyses of current conditions based on the standard, existing and available active data provided in data rooms.  On the other hand, the traditional operations due diligence is at best, a cursory analysis.  Operations is often assumed in the acquisition process.

Operating models have become increasingly complex with global competitiveness, rising customer expectations, disruptive innovation, and new possibilities through digital technology and cultural transformation. Operating model performance has the highest influence on strategic and financial performance, cultural development, and the total customer experience.  Yet it often gets the least attention in the overall due diligence effort.

So how do executives and their organizations change and benefit from the current dilemma?  The answer is simple and easy: With a breakthrough operating model.  This post provides new insights on how to beef up the operations due diligence, build a superior operating model, and cash in big time on these new operating challenges.

Brief Background

The operations due diligence is a small component of the overall due diligence process, where the intent is to scan operations  for something that is glaringly wrong.  Fact is, there’s a lot that’s usually wrong under the radar of operations when organizations choose not to look under the right rugs, ask the right questions to people performing the work, draw comparisons to external best practices and benchmarking data, and construct deeper analytics not found in the data room.  In the majority of cases, most of the current diligence work takes place remotely in a conference room.  In some cases the owners, banks, and VC people even restrict or provide limited access to the manufacturing facility and suggest that additional information be requested through the data room.

These due diligence activities provide confirmation about existing business conditions and abstract synergistic opportunities such as:

• Facility and procurement consolidations;
• Supplier price concessions;
• Headcount reductions;
• Common IT/ERP architecture platforms;
• Increased outsourcing;
• Finished goods rationalization;
• Raw material consolidations;
• Growth from new products;
• Inventory reductions;
• Capacity and throughput improvements, or
• Through many other oversimplified and under-analyzed changes to the operations side of the business.

In essence, the resulting acquisition integration plan is a promising read, but full of unknowns and black holes about how operations will deliver the goods. The operations due diligence is more of a check-the-box, fly-by effort, almost as if operations doesn’t matter.  An organization’s operating model is a key competitive lever and should matter a lot – It’s the means of achieving the ends. The problem is that much of the data needed for a thorough operations due diligence does not exist in the data room and is hidden, unknown, undiscovered, institutionalized, or undisclosed.  Additional data room requests often return answers based on opinions, perceptions, or irrelevant information.  It takes experienced operations professionals to create the right narratives (passive data) that make meaning out of the operating jumble, and reveal hidden operating problems and potential disasters waiting to happen.

Passive Data Analysis is Missing

The operations due diligence does not include a vision or guidance about the possibilities of future-state operations.  Passive data is needed for this analysis, and it does not broadcast itself. One needs to seek it out, put clues together, conduct special modeling analyses and tests, and continuously ask Why? Why? Why? Why? Why?  Looking deeper into the details of What, When, Who Where, Why, and How of the above bullet points for example, is so obviously required to achieve acquisition success.  The bullet points above are “desired outcomes,” but the big mystery is always “What, When, Who Where, Why, and How will the operating model be changed to achieve these desired outcomes.”

Understanding how the inner workings of how these processes are actually functioning is often a transactional forensics exercise. Adding in digitization increases the complexity of how to leverage operations.  Some of the required changes might be a cake walk, while others may require a further analysis and/or a significant investment in time, resources, engineering development, technology pilots, and capital.  Some proposed opportunities may not be feasible based on Voice of the Customer expectations. There are no fixed one size fits all solutions anymore.  The devil is always in the details of execution, and prioritization is critical to success.  When organizations glaze over this operational deep core mining, they can’t possibly prioritize and execute upon the right required actions/changes to achieve the desired operating and financial results.

Solution: A More Holistic Operations Due Diligence

The traditional operations due diligence doesn’t provide innovative ideas, guidance, and a detailed acquisition integration and execution plan – The specific details of how the operating model must change from afunctional (people, process), social (culture), and emotional (talent, values) perspective to actually realize the benefits needed for acquisition success. Furthermore the operations due diligence provides no direction of how to integrate innovation and digital technology to create step function improvements in the current operating model.  Innovative organizations are adding major capabilities to their operating models in the form of instant visibility and response via remote access to operating status and real time performance dashboards, predictive and preventive analytics, live operations diagnostics, and interconnectivity between people, process, and equipment.  These capabilities are becoming more commonplace and are desperately needed in acquisitions to achieve the X + Y = Z² effect.

In too many cases acquisition leaders assume that necessary massive operating changes will happen within the acquisition target with the same thinking, same people, same processes, and same information. Brute force and seagull management never works well.  This only produces the same results, more negative inertia for change, and operating performance far below expectations.  Not acceptable!  The answer is simple but not easy: Architect a breakthrough operating mode.

Go Deeper or Go Home

Operating models serve as a blueprint for how the company is organized, and how products and services, people, processes, materials, equipment, technologies, and information are deployed and operated to producebreakthroughs in operating performance. It encompasses decisions about the shape, size, and scope of the business, where to draw the boundaries for each line of business, how resources collaborate within and across these boundaries, how the enterprise will add value to the business units, what behavioral norms and codes of conduct are encouraged and expected, and how to measure progress and success. Operating models are end-to-end and include all operations of the business.

It takes the right seasoned professionals with deep operations leadership, core process knowledge, and broad industry experiences to work through an organization’s operating model in greater detail.  These people have a fanatical interest in improvement, creativity, and idea generation of To-Be best practices.

Organizations need to make the proper investment in a deeper operations due diligence conducted by the right experienced professionals.

A major critical objective of a deeper dive operations due diligence is to uncover hidden, unknown, undiscovered, and undisclosed problems that will have a severe impact on operating and financial performance.  You can’t improve what you can’t see or failed to uncover.  These issues can quickly add up to tens of millions of dollars . . . and they are not documented on reports and never show up in a data room.

You Can’t Improve What You Don’t See or Failed to Uncover

You just can’t do an effective operations due diligence with a two hour plant tour, inexperienced professionals, a few abstract benchmark metrics, the seller’s PowerPoint presentation, and recording off-the-cuff management opinions and perceptions. You also can’t rely on a data room lacking relevant operating scenarios, information, and facts.  You need to get under the hood and understand the What, Where, When, Who, Why, and How of the current operating model.  Getting under the hood also means listening to people who actually do the work every day.  So many acquisitions are commercially and financially feasible on the active data analyses, but everything falls apart in execution.  Why?  Because the traditional operations due diligence approach leaves too many critical operating questions unanswered.  Have you ever seen an obsolete inventory or unplanned downtime or design verification failure report in a data room?

Pre-due diligence planning will become more important. 

As we mentioned earlier, operating models have become increasingly complex.  The boilerplate operations due diligence doesn’t cut it, but the process can not cover everything about the present and future operations in one fell swoop.  We need to prepare for the operations due diligence and define the objectives and scope, what we’re looking for, what we want to accomplish, how operating model innovation and digital technology can create customer value, and the like.   The operations due diligence plan should highlight what is to be accomplished in different phases of acquisition integration.

The operations due diligence must go far beyond manufacturing and include a thorough evaluation of the professional, knowledge-based transactional processes.

This requires an incremental investment in the right operations resources, but the exposed benefits far outweigh the additional costs of a thorough evaluation.  The purpose is to flush out continuous improvement opportunities to the end-to-end, As-Is operating model, and generate new ideas about how to create the ultimate customer experience, achieve operating performance beyond all expectations, and dominate the marketplace.

A deeper dive operations due diligence includes but is not limited to:

• Order Entry and Fulfillment;
• Customer Service;
• Sales and Operations Planning (S&OP);
• Supply Chain Planning and Execution Systems;
• Procurement and Supplier Management;
• Physical Plant Layout, Work Flows, and Wastes;
• Quality Management and CAPA Systems;
• Facilities and Maintenance Management;
• Warehousing and Distribution;
• Transportation and Logistics;
• Time-to-Market and New Product Development;
• Long Term Capacity and CAPEX Planning;
• Performance Management and Measurement Systems;
• IT/ERP Architecture Effectiveness;
• Talent and Human Capital Development; and
• Leadership and Organizational Readiness.

The intent is not to conduct a long, drawn out study of the universe but to understand and focus on the vital few areas that matter the most.  This is the path to immediate fact-based quick-strike improvements and successful transformation initiatives.  Remember that your operating model is a network of the above interconnected operating processes that has an inherent capability by deliberate, accidental, or lack of design. People are performance bound by the operating model capabilities within which they work.  When executives choose not to examine these operating processes and their inner workings in greater detail, they undermine acquisition performance.  These missing details, and a realistic approach about how to improve business model capabilities are a critical element of a deeper dive operations due diligence – We all live in an Improve or Fall Behind world.

The operations due diligence requires an assessment of the executive leadership team and their organization’s abilities to lead and implement larger scale strategic improvement initiatives. 

The operations people who created these situations in the first place are locked into their immediate reasoning routines and management by short term, active data.  The naive precision of spreadsheets, charts, and multiple versions of the facts is easier to react and respond to with the same linear thinking, but it causes people to lose objectivity and creativity.  The same vicious cycle of workarounds and compensating behaviors is not the pathway to major change.  These folks are not usually the ones who are going to suddenly become the “high potentials” and rediscover totally new ways of doing things.  This often requires external injections of new thinking, ideas, and facilitative actions.  A deeper evaluation of functional (people, process), social (culture), emotional (talent, values), and enabling technology competencies, and in particular the detractors and barriers to success are all critical elements of the deeper dive due diligence.

Finally, the operations due diligence must produce an actionable and executable road map to continuously improve and/or transform the current operating model.

I’ve worked with hundreds of clients and never walked into one where significant opportunities for improvement did not exist.  It’s not that organizations are inefficient, the world changes on them while they are deeply rooted into daily routines.  Well to be candid, several are inefficient but it’s a leadership and process vs. personal matter.  Improvement and operating model transformation are leadership choices, where the limit is the self-imposed limit that the organization imposes on itself.

Look at the above bullet points again. There are millions of dollars of hidden, unknown, undiscovered, and undisclosed opportunities in all organizations. We have worked with many organizations who have realized annualized benefits equal to 1.4% to 9.6%+ revenues.  All organizations should be striving for the same results.  Bake these numbers into your acquisition plan and then ask yourself, “Is a deeper dive operations due diligence worth it?”

Provide Guidance on Digital Technology and Operating Model Transformation

The traditional operations due diligence severely lacks innovation in operating model guidance. Too much of the content is active data and spreadsheets, throwing together the As-Is and making it work.  Operating model transformation must be fueled by innovation, a steady stream of ideas, and a culture that is willing to continuously invent and evolve.  Organizations can benefit significantly from additional guidance and whiteboard idea generation to experiment with unconventional concepts, enabling technologies, and for better ways of operating. There also exists a complicated alphabet soup of digital technology solutions that must be carefully evaluated, selected, and integrated into a future state operating model.  Operating model transformation and digital technologies can be very risky, costly, and disruptive with a slam-dunk approach focused solely on technology.  Understanding how these new operating narratives and advanced technologies fit into the operating equation is a missing link in the operations due diligence.  For additional information visit our previous posts on Operating Model Transformation and How To Integrate Lighthouse Pilots.

Small and Mid-Sized Clients Need More Guidance

Many smaller and mid-sized companies need help developing their operating model road map and phased implementation plans. They do not have the resources and capital of larger corporations, so operating model transformation requires a different, adaptive approach in these environments.  The outcome of an operating model transformation strategy is often a bold vision at a higher level of abstraction (This is great by the way), but the innovation ideas and and possibilities can be all over the map. The realm of digital technology solutions complicates things even further. Organizations cannot (and should not) try to do everything but where do they begin?

The operations due diligence must provide practical guidance about how to translate the organization’s abstraction of great ideas into real world breakthroughs. All organizations have difficulty converting their fuzzy operating concepts into real tangible breakthroughs in their business model.  The best way to go about this is through a formal screening and evaluation process focused on value creation, pain relief, and WOW factor identification.  Implementation requires experimentation and may need the use of lighthouse pilot efforts along the journey.

Summary

The big differentiator in great acquisitions is their ability to discover, harvest, and implement the real operating breakthroughs in their industry.  Some of these are more deterministic improvements in As-Is processes (Continuous Improvement), and the higher order breakthroughs require exploration into the realm of unknown and undiscovered possibilities (Strategically Focused Operating Model Transformation).  Organizations must learn to master both to achieve sustainable successes.

Having the presence of a Lean or Operational Excellence program, or mimicking the operating practices of Toyota is no excuse to skip the detailed operations due diligence.  We routinely find millions of dollars in new opportunities with clients who have been involved in Lean and other continuous improvement initiatives for decades.  A renewed perspective on the functional (people, process), social (culture), emotional (talent, values), and enabling technology competencies of operations makes all the difference in the world.  This is true whether it is an acquisition under consideration, a recent acquisition, or an underperforming company in the portfolio.

Radically changing operating models and transformation are words that conjure up fear, stress, anxiety, and something to postpone. But it’s all a matter of the right leadership perspective.  Operations is rapidly becoming a network of intelligent computers, devices, and objects that collect and share huge amounts of data via the cloud where it is aggregated with other data.  The cloud, mobility, data warehousing, business analytics, augmented reality, real time performance dashboards, operational connectivity, and many other applications are being integrated into operations to improve speed, efficiencies, costs, quality, and the customer experience.  IoT and Industry 4.0 are also givens in this competitive economy.  Those that learn to integrate the right digital technologies into their operations will be the new competitive leaders in their industry.

Waiting = Lost Opportunities.  Looking further into this is a “No Brainer” – High value/low cost, zero risk, and only requires 3-4 weeks of effort. 

If you’re ready to step up and benefit from millions of dollars of hidden, unknown, undiscovered, and undisclosed operations opportunities in your organization, contact Terry Burton at the address below or call our offices at 603-471-0300. 

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Terence T. Burton is President and Founder of The Center for Excellence in Operations, Inc. (CEO), a management consulting firm specializing in strategic and operational transformation.  Terry has four decades of extensive operations, quality, engineering, mergers and acquisitions, and supply chain experience as a hands-on practitioner, interim operations leader, and executive in several corporations.  He has led consulting engagements in a wide spectrum of industries, having consulted with over 350 clients in 23 countries on their strategic and operations improvement initiatives.  Terry can be reached directly at burton@ceobreakthrough.com