Joint Partnership Profit Model
Two building supply companies, one a leading manufacturer of external sheathing and the other, a leading manufacturer of sealants, both provide products to commercial contractors when building air/water barriers into external walls. Collaboratively the two companies identified a market opportunity to significantly increase the efficiency and effectiveness of the system, by developing a joint product by pre-treating the external sheathing with the air/water barrier. The combined product could be sold for more than twice the cost of the separate products. However each product had significantly different margins when sold independently and required vastly different capital and cost of goods sold (COGS) costs to manufacture. After reviewing several options for structuring the partnership, including supplier agreements and a Joint Venture, the executive teams turned to us as an independent party to assess how to equitably divide the combined products increased profits while taking into account market risk, combined COGS, increased capital investment and legacy margins.
Our team quickly explored several high level options for funding the partnership and assessing the distribution of profits: Private Equity model, Equal Partner model and a Hybrid model. We moved forward with a Hybrid model. The team quickly determined COGS and profit margin for the legacy independent products to establish a financial baseline and vet each company’s financials. Incremental COGS were calculated to understand the distribution of costs for the new product. When combined with the forecasted market size, a pro-forma P&L was developed to establish a baseline profit from which different distribution models could be created. Legacy profitability was retained, distributing to each company its historical profit on a per unit bases. The remaining profits were divided into two pools: Capital Repayment and Shared Profits. The Capital Repayment was funded with a percentage of the profits to accelerate repayment of capital investments (which were disproportionate between the partners), while funding the Shared Profit pool at a minimum level of profitability. The Shared Profits were distributed based upon the percentage of COGS incurred by each company. The model was parameterized to allow for sensitivity analysis and the impacts of changes to quantity sold, costs, shipping, and manufacturing would have on the profit distribution.
Armed with a quantitative model, based upon both companies’ costs, profits and projected sales, executives from both companies were able to understand their variable COGS, impact of capital investments, and levers for negotiation. Without taking a rigorous and independent approach to building the financial model, neither firm would have been able to articulate and communicate their version of a fair and equitable distribution. Our team facilitated several working sessions to help each company become comfortable with the options, understand alternatives and drive consensus. In addition to providing a quantitative underpinning to the profit distribution, our team was able to keep both parties focused on the spirit of the partnership, while maintaining a strong working relationship. The companies were able to agree on a fair distribution of the profits while enjoying significant increases in overall margins and profitability.