Six Areas of Focus for Strategic Value Creation
Adopting this structured four-tiered approach unveils an array of thematic opportunities for value creation that manifest at various stages throughout the investment hold period. At each juncture in the value creation process, a continuous reassessment of six pivotal areas is imperative. This ensures a proactive response to shifting market conditions, thereby identifying new or expanded prospects for value enhancement.
1. Operational Performance Improvement
When faced with uncertainty in the market, businesses look for ways to reduce costs and improve efficiency. One method that can be used to minimize cost is sharing resources throughout the organization, with the goal of becoming more efficient in one or many functions—supply chain optimization, for example, can yield outsized ROI.
Resources within an organization can be interchanged to meet various needs, allowing the organization to simultaneously improve efficiency and create value. For example, manufacturing facilities, production equipment, transportation channels and procurement functions are resources that may be shareable throughout the business—pending compliance with regulations like those administered by the U.S. Food and Drug Administration, for example.
As businesses grow, whether organically or through acquisition, resources need to scale and adapt. Production facilities, equipment, product inputs and organizational structure need to be designed for efficiency. In addition, processes and services, like application support, help desk and design, can be outsourced or automated to support future growth. Ensuring the business is “rightsized” and taking advantage of outsourcing and automation opportunities can help rationalize and optimize resources while avoiding unnecessary costs.
Some of the benefits of rightsizing the business include:
Shared Operating Expenses: Harnessing a company's entire array of available resources minimizes inefficiencies and unnecessary expenditures. In a supply chain example, and when all regulatory, risk and compliance measures are met, production equipment and facilities can potentially be utilized for multiple product lines, ensuring optimal machine usage. This, in turn, enhances production efficiency, lowers costs for each individual business unit and bolsters overall working capital.
Shared Market Intelligence: By conducting comprehensive activity analyses and benchmarking against comparable companies, business leaders gain valuable insights that can lead to informed, data-driven decisions regarding payroll expenses. These analyses not only identify opportunities for outsourcing, offshoring and nearshoring but also empower organizations to optimize their operations and create cost efficiencies. With a firm grasp on their data, leaders can strategically leverage these opportunities to enhance their business performance and drive sustainable growth.
Simplified Supply Chain and Reduced Procurement Costs: In business scenarios involving physical products and not just services, identifying key raw material resources utilized in manufacturing processes can create opportunities to negotiate more competitive pricing, lowering input costs in production and increasing profits. Understanding critical shipping locations for all customers is also crucial for improving efficiencies and minimizing costs. Organizations can leverage key distribution areas and raw materials to maximize shipments and take advantage of material costs that can be distributed throughout the organization. Other costs incurred by the organization can also be shared throughout the business, ensuring that those costs are creating the appropriate and relative value. For instance, utilizing a single sales function for all products can spread functional costs and reduce overhead.
Private equity firms can work with leadership teams at portfolio companies to identify resource sharing and outsourcing opportunities to help increase profitability and value creation. This proactive approach allows for a more effective allocation of resources, enabling portfolio companies to tackle business scenarios and challenges with increased flexibility.
2. Workforce Optimization
Effectively managing labor and planning for workforce changes also contributes to value creation. Although today’s inflationary environment has shown some signs of slowed growth, interest rates remain high and the labor market remains tight. Portfolio company leadership teams should continuously assess labor, monitor employee satisfaction and implement strategies to leverage current resources.
Private equity firms can create additional value in their portfolio companies by encouraging leadership teams to consider the following talent strategies:
Create Actionable Plans to Reduce Employee Turnover
Given the tight labor market and high cost of turnover, which can range from 50-75% of an exiting employee’s salary to as much as 200%+ for executive turnover, many organizations are undertaking initiatives to improve employee retention. For example, performing regular compensation and benefits market analyses enables organizations to quickly adapt to changes and remain competitive as an employer. Robust learning and development programs support employee professional development and goals and, furthermore, add value to the organization by increasing the retention, capabilities and skills of its people. Addressing career pathing and succession planning, proactive performance management and establishing what the organization’s social and community focuses are (e.g., diversity, equity and inclusion) have all become increasingly important to today’s top talent—and should be addressed in actionable plans to reduce employee turnover.
Efficiently Allocate Resources Through Proactive Workforce Planning and Analysis
In a tight labor market, additional skilled resources may be scarce, making it especially important to efficiently utilize current resources through proactive workforce planning and analysis. By predicting business needs, an organization can efficiently and appropriately allocate resources to help ensure processes run smoothly, business objectives are met and a high quality of service is delivered. Furthermore, effective workforce planning can enable the timely detection and remediation of gaps within an organization and improve operational visibility and financial insight, resulting in elevated decision-making. Promoting coordination, collaboration and communication among the various groups within an organization is another critical aspect of workforce optimization. By establishing open communication channels and ensuring all contributors to a project or process are aligned, an organization can reduce costs associated with duplicative efforts. Fostering coordination also supports organizational agility—a critical capability in a changing economy.
Form Strategic Partnerships to Leverage Expertise, Resources and Customer Bases
To offset the impacts of high interest rates and the low supply of skilled talent, private equity firms can form strategic partnerships to leverage the expertise, resources and customer bases of other organizations. Collaborating with other organizations offers the opportunity to decrease costs through shared marketing and distribution expenses, while simultaneously increasing revenue by accessing new markets. Collectively leveraging the combined knowledge and skills of two or more organizations supports product and service innovation, thus creating value for customers and increasing an organization’s competitive advantage in the market.
3. Demand Management and Planning
Successful portfolio acquirers strategically manage and plan for synergies with potential portfolio companies long before the deal process begins. This proactive approach to assessing portfolio fit is crucial, particularly in today's environment of high borrowing costs and valuations. Coordinated planning synergies are incredibly beneficial and bolster the resilience of value creators, regardless of market conditions. By aligning portfolio company planning efforts, private equity firms can avoid redundant work, minimize costs and swiftly adapt to market dynamics.
To capitalize on value-creation opportunities generated by portfolio-level demand planning, it is essential to apply the following:
Sharing Demand Forecasting
Effective demand forecasting when it comes to physical supplies helps effectively capture potential revenue. By collaborating with other portfolio companies in the same industry, private equity-backed companies can share their anticipated demand, allowing them to better capture revenue and manage inventories while reducing waste. By pooling data from multiple sources, portfolio companies can secure a more comprehensive view of demand trends and patterns, leading to more accurate forecasts, reduced risk of stockouts and excess inventory and increased cost savings and efficiency.
Production Capacity Sharing
Creating and sharing a production capacity schedule can help portfolio companies develop a clearer understanding of the costs and resources involved in each step of the production process. From material costs to labor and logistics, this information can be used to identify and capitalize on potential cost-savings and value-creation tradeoffs. Furthermore, sharing production capacity schedules provides portfolio companies and private equity firms with a competitive advantage through an enhanced understanding of market demands. Pooling portfolio company data helps private equity firms and portfolio company leadership better understand the timing of production and distribution, enhance the balancing of resources across the entire private equity firm and reduce the risk of overproduction or underproduction.
Research and Development Collaboration
Research and development spend can be extensive, but it is often essential to drive innovation and a competitive advantage. According to an April 2023 report by the American Association for the Advancement of Science (AAAS), organizations within the United States invest more than 3% of U.S. gross domestic product into R&D annually. Given the cost and risks inherent in the R&D space, private equity firms are in a unique position to spread the costs and risks over similar portfolio companies. In addition, by sharing resources, including equipment, personnel and expertise, collaboration begins to happen, which can accelerate innovation by increasing knowledge sharing. Enhanced market position is an additional byproduct of R&D collaboration, which enables private equity firms to offer a wider range of portfolio company products and services. This can subsequently lead to increased market share and revenue growth.
4. Vertical Growth
In today's dynamic business environment, organizations are striving to generate value. Adopting a vertical integration strategy fosters partnerships with, or acquisitions of, suppliers and/or distributors that will organically help streamline operations and drive cost efficiencies. By securing control over critical aspects, such as raw material sourcing, production and distribution, vertical integration creates valuable synergies across the organization. From partnering with raw material suppliers to optimizing sales and distribution, vertical integration unlocks numerous benefits and paves the way for sustained success.
Vertical integration can include forward or backward integration. Private equity firms and their portfolio companies assess the needs of their business to decide the direction. Forward integration provides greater control of product distribution through the acquisition of retailers or distributors. Whereas backward integration solidifies product inputs through the acquisition of raw material providers or manufacturers. Key vertical integration strategies and benefits include:
Increased Process Efficiency
Vertically integrated companies gain comprehensive visibility across the entire value chain, spanning from raw materials to product sales and distribution. This heightened oversight enables them to identify and address inefficiencies at various stages, leading to improvements and value creation. Moreover, vertical integration empowers companies to capitalize on economies of scale by rationalizing or centralizing processes. This further enhances operational efficiency and contributes to overall business success.
Improved Profit Margins and Stability
Through vertical integration, companies can capture the profit margins of their manufacturers and distributors. For companies that operate in an industry with a concentrated number of suppliers or distributors, the pricing of raw materials and selling costs can be highly variable. Vertically integrated companies can avoid pricing control by third-party providers, which can allow for increased margins and/or reduced selling prices. Ownership of product inputs and distribution allows an organization to consume the profit margins of previous suppliers and distributors.
Optimized Pricing Strategies
By reducing overhead costs, raw material expenses and sales and distribution expenditures, organizations can lower the price of their offerings while still maintaining profitable margins. Another option is to maintain the existing price point while boosting profit margins, thereby adding substantial value to the company.
Enhanced Supply Chain Control
While other companies are beholden to multiple raw material buyers, backward-integrated companies create the streamlined value chain that helps reduce bottlenecks. Forward-integrated companies increase their control over the distribution of their products, which allows for greater flexibility. Whereas third parties might experience distribution delays due to high demand, vertically integrated companies can better meet the needs of their customers.
5. Revenue and Go-to-Market Optimization
In today's high-valuation deal environment, revenue and go-to-market strategies play a vital role. It is crucial to avoid overestimating revenue during the deal process as it significantly impacts the expected performance of any portfolio company. Overestimation also creates challenges in realizing and scaling revenue synergies at the portfolio company level.
Nevertheless, several opportunities exist for portfolio company leadership to achieve ambitious goals and successfully close deals. Private equity firms can leverage synergies among their sales, marketing and GTM functions at the portfolio company level to drive value. Adopting a data-driven approach around revenue and GTM synergies can enhance the potential for portfolio company success.
Consider implementing the following strategies to maximize opportunities:
Assess Sales, Marketing and GTM Maturity
To generate additional revenue, portfolio companies first need to assess the maturity of their sales, marketing and GTM functions. This includes evaluating the strategy, personnel capabilities and market penetration of each function, as well as tapping into advanced analytics that can provide portfolio companies with customer buying behavior and enhanced customer demand forecasting. By utilizing effective customer data across portfolio companies, private equity firms can identify areas for improvement and develop a blueprint for sustained growth.
Address Product Roadmap Gaps
To achieve incremental revenue growth, private equity firms and their portfolio companies can address product roadmap gaps and opportunities within new platforms and add-ons. By conducting a thorough analysis of existing portfolio company product roadmaps, they can identify areas of improvement in terms of people, processes, data and technology. This analysis serves as a foundation for developing a more streamlined and efficient product roadmap.
Identify Cross-Sell Opportunities
Private equity firms can harness the power of existing customer relationships within similar portfolio companies to uncover cross-selling opportunities. This involves analyzing sales, marketing and product strategies to identify potential synergies. When doing so, it is crucial for private equity firms to possess a comprehensive understanding of the portfolio company's products and customers to maximize the chances of successfully capturing these opportunities. In addition, private equity firms should evaluate how well the portfolio company aligns with their current portfolio, considering factors such as its connection to the customer base, its potential for successful cross-selling and incentive programs. It is essential to assess the portfolio company's leadership and their commitment to the private equity firm's overarching value creation vision. By conducting a thorough evaluation of these aspects, private equity firms can make informed decisions and capitalize on the potential for cross-selling, driving revenue growth within the portfolio.
The utilization of real-time data pooled from similar or complementary products across different portfolio companies should be leveraged to make informed decisions. This data can be used to better understand the needs and wants of customers, ensure all applicable costs are factored into price points, identify demand, consider discounts and promotions and test and implement flexible prices. Leveraging the depths of data across their portfolio, private equity firms can take advantage of the ability to use information to increase their market share.
6. Harnessing the Collective Scale of the Portfolio
For middle and lower middle market private equity firms, while each portfolio company may individually fall into the small- to medium-sized range, their collective portfolio holds considerable negotiating power. Larger private equity firms have recognized the value of a centralized division to manage cost synergies across their portfolio. This collaborative approach can yield significant savings across various areas, including travel, office space, hiring and professional services. Admittedly, implementing a unified cost-savings approach across the portfolio can pose challenges due to differing systems, approaches, timings and specific needs of each company. Despite the initial challenges in implementing this approach, however, the long-term benefits are unequivocally favorable.
Beyond realizing cost synergies, private equity firms regularly organize executive round tables, convening for insightful brainstorming sessions and mutual learning. These round tables, often held on a monthly basis, are structured based on roles, such as CFO, CHRO and CEO. This portfolio-wide approach fosters a sustained knowledge transfer, establishing a robust system of best practices that influences both the current and future portfolio of the private equity firm.