The value of a manufacturing business will be driven by a variety of different factors, many of which are of course common to the valuation of any business (such as profitability and anticipated revenue growth), while there are also many which are specific to manufacturing businesses.
In this first part of a two-part article, we explore these specific factors, and how this knowledge can be used by manufacturing business owners to generate greater value from their investment in their business.
Contracts & Relationships
Manufacturers will often base production forecasts upon existing orders which may have a relatively long lead time. Strong relationships with suppliers are key to ensuring production targets are met.
If these relationships with suppliers are contractual this provides some level of visibility of supply which helps to de-risk the company and increase the potential value of the company.
Operating leases, over both premises and plant and machinery, should also be considered as potentially value-enhancing supply contracts. If any such leases are shortly coming to an end, this increases the risk of a temporary reduction or cessation of production activity.
Similarly, long-term contracts with customers will provide comfort as to the certainty of revenues going forward.
As a result, long-term supply and sales contracts will tend to have a positive impact on value. However, this may not always be so, as companies can become locked into contracts which become onerous and therefore no longer beneficial or profitable, and so caution is strongly advised!
Concentration of Supply & Sales
Reliance on a limited number of suppliers, even if only for a key material or component of a product, creates risk because the manufacturer becomes vulnerable to events such as a failure of that supplier to meet supply targets, or the supplier even ceasing to trade.
This reliance also enhances the power of a supplier when it comes to price negotiations and supply arrangements, as the manufacturer may have little option but to accept the terms laid down.
A manufacturing business also becomes vulnerable if it is relying heavily on a single customer (exclusive supply agreements being a common feature in certain parts of the manufacturing sector), or a small group of customers.
Again, such reliance may put the manufacturer in a weak position in price or distribution negotiations. Furthermore, the loss of a key customer under such levels of dependency can be potentially lethal for a manufacturing concern.
How to add value to a manufacturing business
- Maintain strong and productive relationships with existing clients and suppliers.
- Where possible, having long-term contracts in place will de-risk the business (but be careful about the terms you agree!)
- Wherever possible, diversifying your distribution channels will reduce risk.
Choice of Products
Manufacturers of high-specification, high-quality products are generally able to command higher profit margins as their products are more easily differentiated from those of their competitors, and they need to compete less on price.
Additionally, the ownership of patents, know-how or other intellectual property will create barriers to entry for potential competitors, making it easier to charge a premium on products.
Having a strong brand also allows scope for premium pricing, as the perceived desirability or quality of the product encourages more customer loyalty and less price sensitivity.
There may however be significant threats to the manufactured products from both substitutes and obsolescence.
The pace of technological development means that high-technology products can quickly become obsolete, and so investors will have the expected ‘shelf life’ of products in mind.
The threat of substitutes, that is, products which are not in direct competition to the product but fulfil many of its functions, will be greatest where there are ready substitutes available, particularly for producers of high-quality goods during times of economic contraction.
How to add value to a manufacturing business
- Producers of goods that differentiate on product, rather than price, will tend to be more valuable.
- Investing in the brand can also generate positive returns.
- Keep ahead of developments in the marketplace and threats posed by rival products.
Read part two of this guide to how to enhance value in a manufacturing business.
Find out more about Menzies manufacturing sector services.