By Ashwin Badve
When a buyer looks at a company’s margins, they want to know more than how profitable the business is today. They want to understand where that margin comes from and whether it will continue under new ownership. If the numbers only look good because you’ve frozen headcount, negotiated a temporary supplier discount, or had a strong quarter, a buyer will question how sustainable that improvement really is.
The more valuable improvements come from the products you sell, the mix of those products, and how they’re designed and manufactured. SKU rationalization and design standardization are among the most durable levers in private equity value creation, yet many companies track profitability at the business level without knowing which products are making money, which aren’t, or where the opportunities lie. And I guarantee you, those are questions a buyer’s diligence team will ask.
There are three areas TBM looks at when evaluating product margins: understanding demand, reducing product costs through design and standardization, and building a product roadmap that supports future growth.
Start with demand. Which products sell, in what quantities, and how quickly? Which features will customers actually pay more for? The answers are in 12 to 36 months of sales history and current inventory levels for raw materials, work in process, and finished goods.
That’s where the 80/20 rule often shows up. A relatively small share of products drives most of the volume, yet companies frequently stock out on those high runners while carrying excess inventory on slower-moving SKUs. The high runners deserve the most design attention, but with the right replenishment system, they can require far less inventory.
At a building-products manufacturer, TBM used demand segmentation to separate high-volume, low-variation products suited to a pull system from low-volume, high-variation products better suited to SKU rationalization, the process of reducing a product range to the variants that earn their complexity cost, without losing customers. The analysis identified $5.9 million in potential inventory reductions.
We saw the design side of this at a global pressure-sensor manufacturer carrying more than 800 variations of one transducer family. About 20% were high runners, while the rest were stocked around the world. We used SKU rationalization which reduced the range to 200 to 250 SKUs that still met every requirement of the original 800, moving the final customization to the warehouses. Customers saw no difference.
As I tell clients, “As a customer, I want a vast portfolio to choose from. As a producer, you want the minimum number of products to make it with.” That’s what modular design makes possible.
Product costs come down through value engineering, smarter material choices, greater standardization, and products that are easier to manufacture. But standardization starts with engineering, not purchasing.
A new product design often introduces different materials, components, processes, or equipment. Each variation adds complexity throughout the supply chain, and operations lives with those decisions for years. Using common parts across a product line creates a cost advantage that’s built into how the business operates rather than depending on temporary savings.
Manufacturing efficiency is only part of the equation. You also have to consider inventory, service, and the full cost of supporting the product. An oil drain plug placed on the bottom of an engine may be easier to install during assembly but harder for the customer to service. You’ve made production more efficient while creating costs somewhere else.
Those costs aren’t always visible in product margins. Warranty claims, expedited shipments, field failures, and other expenses may sit in overhead, making a product look more profitable than it really is.
An industrial products manufacturer TBM worked with had developed a strong product but struggled to bring it to market. Different installations required different configurations, which would have meant carrying a large number of finished products. We worked with the team to develop an adapter plate that allowed the same pump to fit different installations. Contractors could carry a few pumps and the appropriate plates rather than stocking multiple configurations. The redesigned product became the company’s top seller the following year.
In 2021, we worked with a PE-owned RV components manufacturer that saw an opportunity to expand beyond its premium market. RV demand was expected to grow more than 30%, while COVID shutdowns had disrupted offshore competitors serving lower-priced segments. To compete, the company needed to reduce costs and nearly double production capacity.
We focused on productivity, product design, and SKU rationalization, using common components across low-, mid-, and high-priced products while changing the features and finishes customers valued. But first, we had to address a fundamental problem: the company didn’t know its margins at the individual SKU level.
The team identified $13 million in potential EBITDA improvement, including $7 million in value engineering opportunities. More than half of the total opportunity came from rethinking how products were designed and manufactured, giving the PE owner a value creation path to improve profitability while positioning the business for growth.
Beyond current margins, PE owners should be asking whether their portfolio companies understand their markets, know which products are profitable, and have a roadmap for future growth. If the entire strategy depends on selling the same products to the same customers, there’s little evidence of where the next stage of growth will come from. Companies need a three-to-five-year product roadmap that’s reviewed regularly, along with a monthly S&OP plan.
One way we help companies turn that strategy into action is through Lean Six Sigma design events. We bring engineering, marketing, supply chain, and manufacturing together to understand customer needs, address design constraints, and find ways to build and support products at a lower cost.
One of the first client I worked on at TBM was at a consumer products manufacturer just months from the launch of a new product. Its internal components wouldn’t fit the housing the design firm had approved. We brought the teams together for design events in January and February, had a workable design by March, and the product launched in April and May. Getting everyone involved early helped solve a problem that could have delayed the launch.
For a PE owner, this work is about more than reducing product costs. It’s about understanding where today’s margins come from and having a credible plan to improve them as the business grows. That’s what gives a buyer confidence in the earnings they’re acquiring.
If a buyer asked where your margin comes from and how you plan to grow it, could you show them? Our Phase Zero Playbook explains how to identify the operational and product design opportunities that can create lasting value.
Article: Year Six and Still Holding: What Buyers Test Before They Believe Your EBITDA Story
Blog: Sell Side Due Diligence: Is Your EBITDA Coming From Demand You Can Prove Before the Process Starts?
Blog: Leadership Transition Risk in PE: Does Your EBITDA Depend on One Plant Leader
Blog: COMING SOON – Run to Demand: What Buyers Look for on the Plant Floor
Key Takeaways
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