Establishing a cross-ordering process in post-merger integration

Cross-ordering in this context stands for a process where acquired and acquiring businesses sell each other’s products and services to customers. Cross-orders can be done between different legal entities (intercompany cross-ordering) or within the same legal entity (intracompany cross-ordering).

This blog provides some practical guidelines and experiences in establishing a cross-ordering process between two ERPs - a topic about which there is not much published knowledge available.

The need to establish a cross-ordering process as part of an M&A deal

The cross-ordering process is most relevant in a corporate level merger or acquisition, where product portfolios are complementing each other or when a portfolio can be sold to new markets or customers via the other corporation. Cross-ordering is not relevant when acquiring, for example, a local entity for market share in a country where the acquirer already has their own sales operations.

Cross-ordering enables revenue synergies quickly. Therefore, it should be started as soon as possible, when both businesses still have their own ERP and supply chains in use. Business cannot wait until ERP consolidation has been done, which might take several years.

Basic cross-ordering process

Most ERP systems have built-in capabilities for intercompany procurement and sales, plant-to-plant inventory transfers, resource cross recharges and warehouse transfers. However, matters become more complex, if operations are managed in more than one ERP and the capability for intercompany and intracompany cross-ordering process has to be established from scratch. This is often the case in post-merger integration after the acquisition of new business, but before consolidating the IT systems and processes.

In a customer order driven business, cross-orders are placed to the source of supply (acquired business) based on sold products. When volumes are large, orders need to be delivered electronically (EDI, iDocs, XML) via Enterprise Service Bus (ESB middleware). Delivery and invoices are also delivered electronically.

The intercompany cross-ordering process is very similar to any procurement process with an external supplier. The main difference is transfer pricing. The intracompany cross-ordering process, however, does not include invoicing at all. The delivery is instead treated as an inventory transfer. This is more complex to implement because ERP systems typically require a complete end-to-end process from order to invoice.

Master data set-up

The cross-ordering process requires master data opening to both ERPs:

• Internal customer and vendor codes

• Products and services

• Transfer prices (for the intercompany cross-ordering process)

• Inventory prices (for the intracompany cross-ordering process)

Inventory prices are very dynamic and typically need to be updated every month. Differences in inventory prices lead to inventory value differences and respective posting to P/L.

System-to-system integration

If possible, it is better if there is only one ESB middleware in use. However, system consolidation takes time and two ESBs are most likely involved, when the cross-ordering process is established. ESB will do data encryption, data validation, data mapping, data transmission and technical status/error reporting between the ERPs. Data mapping is needed to transform customer, vendor and product codes, because the numbering schemes are not the same in both ERPs.

IT system configuration

The goal is to avoid system configuration and to implement the cross-ordering process with simple master data opening. ESB mapping rules have to be established with a specific configuration to enable intracompany cross-ordering that is not a typical process in ERP. End-to-end testing is needed for different product and logistical scenarios.

Accounting in intra-company cross-ordering process

The intracompany cross-ordering process does not involve invoices. Materials and finished good transfers are instead treated as inventory transfers. The basic principle is that inventory value does not change during the transfer. The source of supply books materials out from inventory and the selling entity books inventory in with the same price. In the case of direct delivery to customer, inventory is booked immediately to Cost of Sales or WIP inventory. The accounting process must be established to ensure that inventory transfer happens with the same price and in a synchronous way between both ERPs. This requires special inventory transfer control accounts, technical interface monitoring in ESB, a reconciliation process and possibly also corrective financial postings at the period closing.

Special considerations in service and software cross-ordering

Services are not always handled in ERP in the same way as products. Sometimes projects and resource time registration is handled in separate systems. Resources and projects must be opened to respective tools to facilitate time-based service cross-ordering. Service costs are then transferred with or without margin at the period end between entities. Depending on the industry, software can be classified in many ways and consequently treated differently in accounting and in customs declaration and duties. OEM software is typically inventory controlled with price, but immaterial SW, like licenses, do not have an inventory price. Cross-ordering also has to be able to deal with different types of SW.

Business and organizational impact

Business wants to establish cross-ordering as soon as possible to realize revenue synergies. Therefore, it becomes a high priority project immediately after the M&A deal has been closed. Cross-ordering could happen in both directions, depending on what legal entity / operation made the customer sales. Before the legal entity merges, a process is needed to decide which legal entity is selling and which one is supplying. A joint product management team is also needed to define the joint offering to the market. As discussed earlier, an inventory price update process and reconciliation process for inventory transfers needs to be established.

Summary

The cross-ordering process is one of the high priority integration streams in corporate level M&A deals. Midagon has experience in several post-merger integrations and country legal mergers and is glad to help its clients in different roles, like program and project management, concepting, test and cutover management and as an advisor.