Mergers and acquisitions can help drive a company's success in the services market.

The market for pump services is in a state of flux. Although it is highly fragmented, it enjoys relatively high growth in developed economies. A number of important factors should be kept in mind when evaluating the marketplace:

  • Aftermarket competitiveness is critical because it discourages users from purchasing new equipment from competing manufacturers.
  • Aftermarket revenues tend to be less strongly correlated (and in some cases, even inversely correlated) to economic cycles, so the servicer's revenue portfolio can be stabilized.
  • The demand for outsourced services expands as the available pool of service personnel shrinks.
  • The services market benefits from the already high and increasing opportunity costs associated with an end users' replacement of equipment. The crippling costs of plant downtime are a hidden replacement cost, placing long-term reliance on service providers.

As the cost of equipment failure increases along with the age of the installed base, an end user's competitiveness rests on its approach to repairing and maintaining its rotating equipment. At the same time, the manpower available for such services is decreasing, so end users are increasingly outsourcing their maintenance and repair operations. These service providers have enjoyed significant growth throughout the last decade. During this time, pump OEMs have unlocked additional value in their aftermarket service businesses through mergers and acquisitions.

Strategy 1: Adjacent Technologies

Having an excellent direct service infrastructure already in place carries a number of benefits. These manufacturers enjoy a much longer menu of acquisition targets than other firms because they can create additional value by leveraging their service delivery capabilities.

Consider the strategy of acquiring adjacent technologies. This strategy involves a pump OEM's purchase of a company whose product or service is complementary to the pump technology or the service infrastructure's technical capabilities.

Technologies with enormous aftermarket requirements are helpful examples. The acquirer's service delivery infrastructure would likely bear considerable influence on the end user's purchasing decision. Since inadequate service infrastructure would be a significant constraint to the firm's growth potential, an acquisition by a pump manufacturer that already has a robust service delivery infrastructure in place that closely overlays, geographically and technically, the target firm's market would be able to generate faster growth than the target company on its own. The benefits of such a combination are compelling:

  • Higher asset use at the purchaser's service centers
  • The elimination of most capital expenses associated with the aftermarket component of the target company's business development strategy
  • Higher growth rates earlier in the target company's development

 In recent years, a number of transactions have allowed pump OEMs to improve their service asset use and leverage their preexisting asset base to gain greater value from their target companies.

Even ignoring the potential benefits of technological integration, these merger synergies can be so significant that they allow the purchasers to enjoy superior returns despite more generously-valued transactions.

The transaction significantly grows B's revenue without increasing the assets of

The transaction significantly grows B's revenue without increasing the assets of the combined firm.

Strategy 2: Local Service and Distribution

Expanding direct service infrastructure can have different motivations for different manufacturers. Although aftermarket revenues are often quite tempting to pump manufacturers, centrifugal pump manufacturers in particular, improved service infrastructure can also provide a way for manufacturers to expand to new geographies or markets. The most obvious way of achieving this is by purchasing a distributor or OEM, but systems integrators have also emerged as possible service partners.

Purchasing an excellent distributor or OEM in a new geography can give the purchaser the opportunity to use the distribution and service infrastructure to push new products. These new products can then pull services later on as the installed base of equipment increases.

From a valuation standpoint, this implies that sales and growth projections can include an aftermarket multiplier effect from the projected increase in new product sales. The transaction's synergies become more apparent if the manufactured product is best marketed with local aftermarket service coverage.

Partnering with a systems integrator can also provide some helpful benefits in premarket services. Since premarket services are marketed or packaged with new equipment, a systems integrator can provide an excellent foothold by which a manufacturer can increase its installed base in a new market.

Whether a manufacturer decides to purchase the target for its equipment or aftermarket opportunities, this type of transaction carries with it some potentially serious risks. For example, any potential value destruction arising from the distributor's lost supplier agreements with other manufacturers must be carefully weighed against the purchase's business and strategic benefits.

Strategy 3: The Installed Base

Manufacturers with large installed bases of serviceable equipment do themselves and their end users a disservice when they fail to provide excellent aftermarket services. A manufacturer that has secured a large installed base of serviceable equipment but does not follow up with great services is vulnerable to competitors who do. An acquirer may have only a mild interest in its target's revenue-generating activities if the target firm's installed base and customers are easily served by the acquirer's preexisting service capabilities.

These synergies, as with Strategy 1 above, are difficult to realize unless the OEM is the end users' preferred service channel and the acquisition can significantly improve the acquirer's return on service assets. A more straightforward approach might simply be to service the target firm's customers without its blessing. New equipment sales may eventually follow, eroding the target firm's installed base and market share.

This approach is less promising than Strategies 1 and 2. The real value to this transaction is that it would improve the combined firm's return on service infrastructure assets, but it seems likely to work only in situations in which end users prefer to deal with the OEM and in which distributors and other service channels are weak.

Strategy 4: The Underused Service Infrastructure

Some manufacturers recognize the value of a great service delivery infrastructure but lack the resources to develop it exclusively for their own products. It may be easier for these manufacturers to expand their service infrastructure as a by-product of acquisitions of other equipment firms.

This example is the reverse of Strategy 3. Strategy 3 involved the purchase of a manufacturer for its installed base so the acquirer could service it with its own assets. Here, the acquirer is interested in the target's service infrastructure, so it can better service the combined firm's installed base. One constraint is that the merger synergies must not exceed the value of developing similar, in-house service assets.

As with Strategy 3, the synergies lie in improved service asset use. This strategy is best viewed in the context of the broader transaction, where service is only a piece of the merger's benefits. Likewise, just as Strategy 3 is an alternative to simply stealing a competitor's service customers, it is the acquirer's customers who are vulnerable in this situation.

Rethinking the Competitive Landscape

Service provides stable revenue while protecting an OEM's customer accounts from competing manufacturers. These suitors can win new equipment sales from an inattentive OEM by providing good aftermarket services.

Only the largest manufacturers have the installed base necessary to justify an extensive direct service strategy. Having the infrastructure already in place creates a number of advantages.

For example, merger and acquisition strategies involving adjacent technologies can generate tremendous benefits for small, innovative target firms that who lack the necessary resources to further develop their products. Such transactions allow large companies to increase infrastructure use and deepen customer relationships. A large service infrastructure broadens an OEM's spectrum of acquisition opportunities.

There are also a number of growth opportunities for smaller and medium-sized manufacturers who want to expand their markets. A forward-integration strategy can provide a smaller manufacturer a strong enough toehold in a new market from which to expand market share.

It is critical to keep in mind that there are significant competitive opportunities and threats in either underused service assets or a neglected installed base. An aggressive, service-focused acquisition strategy can preempt some of these competitive threats.

Pumps & Systems, November 2010