Private Equity firms approach acquisitions with a singular focus on driving long-term profitable growth. Their aim of course is to realize a company’s true value and potential. Their objective ‘outside in’ approach rapidly zones in on changes that need to be made. And as our guest writer Christelle Espinasse says, many of these approaches can be adopted by businesses in general to drive long term growth.
Heard of the ‘outside in’ perspective? It’s what Private Equity (PE) firms can bring to their portfolio companies. Especially in the first few months following acquisition. So what does it mean? Put simply it’s the PE’s ability to review a business in an objective fashion. One that isn’t hampered by cognitive biases which leadership teams can naturally develop. These biases can include:
Of course all companies are in business to create value for their stakeholders. Some successfully follow the correct course and sustain it over time. Others fail. So when an investor steps into a company they will rapidly identify what needs to change or adapt to realize its true value. Even if the organization is succeeding, they will pinpoint where further improvements can be made. Let’s consider seven approaches they might take.
Reset the discussion. Vigorously challenge every dollar in the annual budget to build a culture of cost management. Zero-Based-Budgeting (ZBB) can help find the most efficient return on spending, from the bottom up. It provides greater visibility on cost drivers and categorizes each activity as either ‘must have’ (e.g. a legal or regulatory requirement), ‘required to have to support differentiating capabilities’ or ‘nice to have’. The objective is to eliminate as many ‘nice to have’ expenses as possible. These can then be reallocated to growth-related activities e.g. marketing, sales, and M&A.
This involves tight management of accounts receivable and payable. Linked to that is inventory optimization of lower-value discretionary expenses, and high-value spending. By doing that you shift the mindset. It gets managers thinking how they would improve the situation if the money was coming out of their own pockets. Essentially you move from ‘arguing things in’ to ‘arguing things out’. This triggers the realization that no spending is too small to be reviewed. After all, one hundred small changes that save $100,000 apiece still add up to $10 million.
Developing and implementing a strategy that delivers long-term profitable growth demands an objective, dispassionate approach. Decisions need to be made as to what to start, stop and continue doing. And it’s the stopping that can cause issues. Ultimately, what is core to the business? Cognitive biases can blur decision making. That’s where the ‘outside in’ approach is key. The objective perspective enables clearer calls on which low-value activities to eliminate for short-term cost benefits and the real high value ideas that demand investment.
The PE world is about action. This is exemplified by the 100-day program they place on portfolio companies during the first few months of ownership. That period is considered critical to implementing identified strategic changes. However, remember many businesses have to navigate layers of oversight for change to happen. So it is important to find the right balance between the need for consensus, and the need for speed. Remember, waiting too long to implement change can profoundly impact a company’s future outcomes.
Strong and effective leadership teams are critical to the success of PE firms’ investments. In fact, they often invest in a company based on the strength of their management talent. Underperforming ones are promptly replaced — one third of portfolio company CEOs exit in the first 100 days. Never underestimate the influence of middle managers either. They are critical to the successful execution of a strategy. Never forget, talent management is not a frivolous activity – it is a must to success. Always put the effort up-front to secure the right team.
PE firms manage portfolio companies by developing key measures, in a few areas critical to success. They then set clear, aggressive targets and track them, relentlessly. Whilst many businesses have performance tracking through key measures, they are usually disconnected from long-term value creation. The long-term strategy should drive a set of specific initiatives, with explicit objectives that link to annual plans and budgets. This creates a direct operational link between strategy and the business.
PE firms pay modest base salaries to their portfolio company executives. This is counterbalanced by highly variable and annual bonuses based on company and individual performance. And a long-term incentive compensation package tied to value creation realized upon exit. Consequently, the fortunes of CEOs and their leadership teams are directly linked to the performance of their businesses. Bonuses are only paid when the performance targets are achieved. Setting a tighter link between pay and performance, particularly over the long-term (instead of annual) helps truly reward star talent and stimulates a high-performance culture.
Their best practices provide powerful pointers that can be adapted to the realities of many companies to build an engine for growth. The key is to start with an objective approach that cuts to the facts, figures and true indicators. Not necessarily the ones we would like to believe are true.
Christelle is an Independent Consultant with more than 20 years’ experience in strategy in both “branded” strategy consulting (including for PwC Strategy Advisory Services) and industry line experience, having worked for five years as a Managing Director and Regional Head of Strategy for Asia-Pacific for the Royal Bank of Scotland. She understands the flaws of both strategy practices and has experienced first hand similar issues to those she helps her clients address.
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