Levers to Increase Enterprise Value

Dorn Group’s James Dorn and Tom Gale recap some of the key themes from MDM’s recent Distribution M&A Summit and outline the most pertinent areas of improvement for EBITDA margin, growth and value.

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Podcast Transcript:

Tom Gale: Welcome to this week’s edition of MDM Quick Takes. I’m Tom Gale. My guest this week is James Dorn, president and CEO of the Dorn Group, the strategic growth advisory firm that has supported industrial distributors and manufacturers for more than 45 years. James, welcome.

James Dorn: Tom, thank you.

TG: Last week, MDM hosted its third distribution M&A summit. This one was virtual that brought together about 150 leaders across many distribution sectors for an update on the distribution M&A landscape and outlook for 2023. We had an incredible group of presenters and panelists, distributors, private equity firms, investment banks, strategic advisories. The presentation slides by themselves are powerful resources for strategic planning. Whether you’re actively engaged in any M&A process, presently or not. For a limited time, we’re offering the entire program nearly eight hours of content on demand. You can contact us by email at events@mdm.com, and we’ll share more details on the agenda. The sessions, speakers. It’s also on our website under the events tab in the navigation bar over the two days of programming that we produced, the core theme naturally centered on enterprise value creation, whether in the ways that sellers can position for a sale or how buyers can increase value in an acquisition.

There was also a powerful parallel theme that touched me deeply, and that was around wholesale distribution in North America is incredibly healthy for supplier partners, for owners, for associates, and cusTomrs. In spite of the challenges around supply chain and everything else everybody’s been going through these last three years, what we heard last week were so many stories about building value from every angle. From an investment thesis, but just as importantly from the entrepreneurial and culture thesis that’s out there that has always made distribution such a powerful industry and value to industries and sectors everywhere. You attended the event, James, so I’d love to get your takeaways from it and to have a deeper conversation about the levers that distributors have this year to increase enterprise value. All the advice that we heard last week that was centered around potential selling or buying, even if you’re not and you’re just interested in growing and strengthening your business, these levers around enterprise value are the keys for anybody.

JD: Yeah, I think that’s well said, Tom, and it’s a great point for companies to keep in mind because no matter where you’re at on the M&A journey, whether you’re on the buy side, whether you’re in the hold cycle, or if you’re on the sell side, or just even in that hold period, you could be early in the hold cycle or later stage. What really comes through in this session, Tom, at the M&A summit, was what’s key is the incremental enterprise value that you can create as a leadership team. So in order to do… And that’s really where the hard work is. So once you’ve purchased something, how do you create that incremental value? And that’s where I think there were some great insights shared on what are those value creation levers that you as a leader in distribution can keep top of mind?

I’ve got a few here in front of me, Tom. One of them was pursuing inorganic bolt on acquisitions is certainly one that comes top of mind, but I think the harder ones to achieve are really on the organic growth side of things, where you start getting into revenue and growth, which would include do you have a strong growth plan over the next three years, and is that growth plan somewhat vetted to where it will give a new buyer some confidence that it’s actually going to be achievable? Sales effectiveness, pricing, market development share, wealth gain, all that would kind of be rolled up into that type of lever of revenue and growth. Cost and operational excellence was another one. What’s the cost to serve and what’s the working capital, turns, things like that to where there’s just a lot more diligence and emphasis put into that lever as an organization. Digital and tech. Obviously with omnichannel, digital analytics, that’s another big lever. And the final one I made note of was really talent, talent development, retention and how good you are as an organization about recruiting and maintaining the top talent out there.

TG: Overall, it feels as though there’s been this acceleration over the last few years, and I think this was born out in the conversations in our summit last week, that the level of professional management keeps increasing. And all of those points that you just talked about, James, each one of those are opportunities for really any size distribution company to go into any of these areas and see some significant impact drop to the bottom line. These were the playbooks, those things that you mentioned across the revenue growth. Cost and operational excellence, digital talent, these are all the things that private equity firms are investing their time and effort in and due diligence to determine once they come on board, bring their expertise, extract that value out of these companies that at their core have great value propositions in terms of where they are with their cusTomrs and those relationships, but how can they really squeeze additional value and enterprise value out of that going forward?

JD: And Tom, that is where all the hard work is, and that’s where we as a firm live in that day in, day out, helping leadership teams do a lot of this because the organic growth is far more difficult than inorganic strategies that you can pursue with add-on acquisitions and whatnot. A story comes to mind for me, Tom, of one of our distribution clients that kind of ties a lot of these levers together into a single initiative for the organization. This client was more construction focused distributor. They wanted to improve their stock and flow business, and when you look at the increase in turns just to help with working capital and the stock business is definitely a higher gross margin. So it’s one worth focusing some energy and resources around. But for this distributor, our goal was to put together a category sales and marketing plan to help them increase their average order size and their number of lines per order.

So we wanted to take them, I think from, say, 2.8 lines per order to maybe 3.5. Now, some might be thinking out there like, oh, that’s so insignificant. How does that even add up? But if you’re a distributor of a certain size, for this distributor, I think they had over 20,000 active cusTomrs, over 500,000 orders per year. So that adds up. If you can focus your teams on just simply driving average lines per order up, it can make a huge impact. For this client, it was probably top line gain of over 6% growth with maybe a net profit improvement of over 10%. Now, when you think about maintaining your same SG&A or overhead, that makes a big impact to your bottom line.

TG: How heavy a lift was that?

JD: I think for this one, Tom, diving into what we actually did, a big part of it was through cusTomr segmentation, looking at the accounts where we could actually grow share of wallet with. We looked at their transactional data overlaid with some market demand data thanks to MDM, and tried to really find gaps at the product level and at the account level. And then we gave our teams playbooks to actually go after those accounts and increase lines per order. And presto, it happened, right? And it actually improved Salesforce optimization. It improved sales effectiveness overall. And when you look at the net impact for this company, I mean, you’re talking maybe a 200 BIP increase in EBITDA, going back to some of those multiples that we talked about earlier.

If you can increase your EBITDA margin by 200 BIPs, that’s a really big check that’s going to be written when you have, you start talking about 10 or 14X multiples. To a closely held business owner, that type of exit multiple based on that EBITDA gain, that is some serious money. I mean, that’s moved to Naples, Florida type money for that closely held business owner.

TG: And just to be clear, for those living in Naples right now, that James, you’re referring to those closely held business owners becoming their neighbor, not necessarily you becoming their neighbor. Is that correct?

JD: That that is correct, yes. They are making the money, Tom. We’re just helping them make that money.

Tom Gale: I just wanted to put their fears at rest there. When you talk about Salesforce optimization, where they’re supposed there specific incentives that you needed to put in place, because there’s a lot of this back end the analytics piece is around the cusTomr segmentation, and ultimately the execution piece is really you’re not going to get that 200 basis points unless you get the execution right. So can you just talk a little bit more about what that execution looks like?


JD: Yeah, it’s a great point to dive into Tom, because it’s one thing to identify the cusTomrs who may have more potential. It’s another thing to actually have market demand sizing by individual product categories, and then to identify which one of your cusTomrs is most prone to buy those additional adjacent product categories from you. So being able to give that level of intelligence to your sales and marketing teams gives them a headstart into who they should be focused on, number one, and number two, what product categories they should be focused on. And then you give them these conversion programs to where they can say, hey, you’re not buying this from us. Here’s our value prop around that. Here’s where we have a certain level of value that we can provide to you, Mr. CusTomr, to help you to win this business from you.

You’re already doing business with us here. We want you to do business with us over here as well. So that level of intelligence and the tools to actually effectively convert the cusTomr into your value proposition at a category level is really where the deals are won and where a lot of the traction is gained.

TG: James, thanks for your thoughts on this today. I really believe this current business cycle we’re in right now, all of these aspects are so critical to build a successful year. Thank you. I look forward to our next conversation.

JD: Yeah, absolutely. Tom, it was great to be here with you in the MDM community.

TG: If you’d like to learn more about the agenda, content, and topics of MDM’s 2023 Distribution M&A Summit, we’re making that available on demand for a limited time. Please contact us at events@mdm.com. Thanks for listening.