The single biggest disruption affecting private equity
Digital is more profoundly impacting all aspects of the private equity industry than some Private Equity (PE) firms realize.
PE firms need to assess their current and future portfolio companies from a digital perspective, and they also should consider the impact of digital disruption on their own operations.
"Digital" means different things to different people. To some people, digital is a marketing platform through a website, email, and mobile and social strategies. To others, digital is disruptive technology fueling new business models in car sharing, online groceries, peer-to-peer payments, smart meters and office space. And still to others, digital means an explosion of data.
Digital is all of the above.
How should digital transformation affect diligence?
As part of their diligence process, private equity firms should understand digital's impact on their overarching investment thesis, including their commercial, technology, financial and talent assessment.
In particular, PE firms need to know how potential target companies are poised to manage the digital disruption that is entrenched in the target’s sector, from marketing, sales and customer care, to the supply chain to intellectual property, to data and security requirements.
A very telling sign of a target’s digital maturity is by who “owns” digital. Companies with a sophisticated view of digital, looking at everything they do through a digital lens and embracing disruption within the supply chain, partnerships, commerce, talent, marketing, sales, customer care, corporate development, legal, and tax, will say the CEO owns the digital charge.
Think about digital’s impact on the customer experience, for example, when buying a new car. You can view make, model, offer price and inventory online, but you still need to walk in and buy at the dealership. The customer’s expectation is to have all of the information they need by the time they arrive to make a purchase.
Consider the “born digital” generation. PE firms with portfolios serving the higher education sector must adapt as the industry undergoes a massive transition from bricks and mortar only to bricks and mortar plus online learning, an area traditional schools “have previously ceded to the for-profit institutions,” says Glenn Engler, Managing Director at Parthenon-EY and the US Digital Lead for Transaction Advisory Services at EY.
The point is, disruption has changed the entire customer journey and may necessitate operating model changes. Without a rigorous digital diligence on potential investments, you have not fully calculated your risk and opportunities.
Start by asking these questions:
- How are key trends in the target’s industry reshaping the way the target company operates?
- What is the impact of digital on the investment case and the target’s valuation?
- What financial impact is digital having on the organisation, and how does the target measure it?
How can digital advances create value in your portfolio companies?
Digital disruption can enhance PE portfolio company returns. But you need to understand the trends in value creation by asking:
- Which competitors may not be obvious today?
- What technologies can destroy profit across the current value chain?
- Is it time to divest part of my portfolio due to new disruptive competitors?
- Should I exit or double-down?
Take the Internet of Things (IoT) — the proliferation of linked sensors that connect machines and a disruptive technology with the potential to profoundly affect many industries. While the biggest benefits of IoT technology so far are cost savings through optimizing energy usage and predictive/preventive maintenance to minimize downtime of core machinery, new opportunities are emerging.
“For example,” according to Engler, “we surfaced value creation opportunities for companies in the waste management space, leveraging the presence of sensors in the equipment to increase operational effectiveness in areas such as telematics and routing, add to potential revenue and provide new business growth in adjacent market categories.”
In order for PE firms to create more value for their investment portfolio regardless of industry, they need to consistently evaluate the digital capability and strategy of the individual businesses. Organic digital initiatives can take years to reach the bottom line, so PE needs a more proactive strategy to protect their investments — whether that’s a carve-out, exit or doubling down on the existing business.
What’s your own business strategy in a digital world?
The other side of digital disruption is how it affects private equity firms internally. Most firms are set up extremely leanly to focus on investing in their portfolio companies and improving operations, but not so much on their own operations. However, digital can have a major impact on a PE business, both with external stakeholders (investors, analysts and partners) and internally (via data security, risk and talent engagement).
“We ask companies to reframe the question from, ‘What is your digital strategy?’ to ‘What is your business strategy in a digital world?’” Engler said. "At one PE firm we work with, when I shared that phrase in discussing their portfolio companies, one partner looked at the other partner and said, 'By the way, what’s our business strategy in a digital world?' There was a big pause in the room."
Considering privacy concerns, cybersecurity threats and investor demands, PE firms must regularly address their digital ecosystem to future-proof their enterprise.
Start by asking these questions:
- Should I develop digital capabilities internally or buy?
- How can I keep up with my peers?
- How can I make my firm more agile?
How EY can help
Digital is creating incredible opportunities — especially for those who can execute big and fast. But today’s industry giants are rarely geared to organically develop top-class digital capabilities.
EY helps private equity evolve in line with the changing digital environment by asking better questions around our clients’ digital future and discovering the answers through our capabilities, talent and global network. Getting to the root of these questions helps our private equity clients operate more efficiently, manage risk, inspire confidence and grow.