7 minute read 18 Mar 2022
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How private equity is addressing the future of value creation

By Gregory Schooley

EY-Parthenon US Value Creation Leader; Principal, Ernst & Young LLP

Seasoned executive combining operational, M&A and strategy experience. Trusted advisor on critical business decisions. Passionate and proactive who values a healthy debate. Father and traveler.

7 minute read 18 Mar 2022

Leading PE operating partners share lessons at the EY Strategic Growth Forum®

In brief

  • PE firms are focusing on how they are attracting and retaining people, using digital operating models and automation, and outsourcing functions.
  • Traditional levers such as strong cost management and lean manufacturing will continue delivering value for private equity investors, but may not be enough.

Private equity (PE) investors who adopt advanced tools for value creation can differentiate themselves despite fierce competition for assets and narrowing time frames in today’s fast-paced deal market.  

“The path to successful value creation these days goes beyond typical levers such as G&A cost-cutting, sales force effectiveness and strategic sourcing. It’s about an approach that leverages digital tools including automation, strategic outsourcing and advanced analytics,” said Greg Schooley, Value Creation practice leader at EY-Parthenon. “PE leaders and portfolio management teams have to look beyond the old playbook that they’ve been using for the last 20 years.”

Schooley made the comments at the recent EY Strategic Growth Forum® (SGF) as part of a panel discussion with leading PE operating executives who spoke about hot trends in value creation. The panel members said the best opportunities to create value occur in several key areas: creating digital and automated business models; strategic outsourcing; addressing environmental, social and governance (ESG) factors; and hiring and retaining talent.

Digitization and automation

The situation: Private equity-owned companies may need to move faster to automate processes and digitize business models, the panelists noted.

For example, new forms of digital engagement — personalization based on data, social listening and digital marketing — can better measure rapidly evolving customer habits and demands to avoid customer churn and transform products and services. The best online shopping experiences are raising the bar for B2B as well as B2C interactions “because a B2C environment is everybody’s expectation,” said David Gau, Partner and Head of Operations, Pritzker Private Capital, who also spoke at the SGF conference.

The solution: A surprising number of processes may need to be automated and interconnected, including inter-company product reconciliation processing, invoice payments from multiple systems, as well as processing of payroll, tax exemptions, utility bills and other general accounting and reporting tasks. According to the 2021 EY Private Equity Divestment Study, 51% of PE firms see artificial intelligence (AI) as an important value lever for portfolio companies over the next 18-24 months. In addition to increased automation of process and controls, AI can also support forecasting and decision-making that directly impacts margin enhancement and cash conversion.

Like larger organizations, mid-size PE-owned companies likely need to invest in activities that create value vs. those required to keep the business running. Value-creating activities can receive outsized investment in time, capital and focus where “keep the business running” activities can be automated, streamlined or outsourced.“For us, one way in which we support our entrepreneurs is by removing distractions. We want to ensure they have the ability to focus on issues that are core to growing their business,” said John Toriello, Managing Director and Global Head of Transactions, General Atlantic, who spoke at SGF.

For us, one way in which we support our entrepreneurs is by removing distractions. We want to ensure they have the ability to focus on issues that are core to growing their business.
John Toriello
Managing Director and Global Head of Transactions, General Atlantic

ESG in private equity

The situation: Private equity professionals are under enormous pressure from their limited-partner investors to incorporate ESG goals into their strategies and businesses. Executives rank ESG initiatives at the firm level among their top three strategic priorities, after top-ranked talent management and product/strategy expansion, according to the EY 2022 Global Private Equity Survey. As ESG becomes a new driver of disruptive change and its importance rises, expectations shift from risk management to value creation for both targets and portfolio companies. Some PE investors say a company’s ESG profile can determine whether a deal gets done.

The solution: “We are looking at climate and carbon intensity. It has to improve over the life of a portfolio company. We’ve got to build capabilities to do it,” said Aaron Miller, Partner, Private Equity and Head of Performance Solutions at Apollo Global Management, who spoke at the forum. “If a company is not thinking about it [carbon intensity] as ‘I need to fundamentally improve on these metrics,’ it may not be viable for us to buy it.”

ESG due diligence helps PE uncover value in target companies by examining products and services from cradle to grave, from source materials and multiple supplier tiers to waste and recycling. But for companies that are already part of PE portfolios, operators can mitigate ESG risks or capitalize on its value-adding opportunities. One way to do this is to conduct an ESG materiality assessment of assets to identify emission-intensive companies and opportunities to reduce their carbon footprints. Other approaches include training deal teams in ESG skills and directly investing in ESG initiatives at portfolio companies.

We are looking at climate and carbon intensity. It has to improve over the life of a portfolio company. We’ve got to build capabilities to do it.
Aaron Miller
Partner, Private Equity and Head of Performance Solutions at Apollo Global Management

At the same time, PE and portfolio company management teams may need to be asking: What ESG metrics can be used to measure a company’s success? What are the reporting requirements? And who will implement and oversee ESG policy?

PE can also uncover new opportunities for value creation as ESG is embraced by more stakeholders. An ESG strategy also includes efforts to create purpose-driven businesses that can attract a broader base of talent and customers and create value by embedding sustainability in their business strategy, transformation program, reporting metrics and communications.

Talent recruitment and retention in private equity

The situation: Given the shortage of talent across the US and globally, private equity teams and portfolio companies may need to compete with the rest of the corporate world for the best people. In the wake of the COVID-19 pandemic, the struggle to attract and retain employees has become more difficult and costly. Unfortunately, many PEs don’t pay sufficient attention to this critical area, said Apollo’s Miller.

“Deal teams are more focused on filling a chair with someone they think is ‘good enough,’ vs. filling the chair with an A player — the gap between ‘good enough’ and an A player makes all the difference,” said Miller.

The solution: PE owners and management teams can recognize talent as a value creation lever by starting with a more systematic understanding of employees’ expectations and areas for improvement. They can conduct quantitative research, based on real-time compensation data analysis, employee interviews, social media scraping and other methods, to identify problem areas in the recruiting process and the reasons behind employee turnover.

Portfolio companies can also perform a strategic review of talent acquisition and onboarding to understand which candidates will bring the greatest value, what factors drive attrition by role, what hiring sources have the highest success rates and the cost-effectiveness of recruiting overall.

Insights gathered through these steps can help PE and management teams develop a strategy to mitigate attrition rates and transform the culture to attract, motivate and retain talent.

Organizations that adopt these approaches can see significant EBITDA upside from higher productivity and talent acquisition cost reduction.

Outsourcing strategically

The situation: Historically, mid-sized private equity-owned companies have resisted outsourcing for fear of service quality and a belief that outsourcing is more appropriate for larger enterprises. Going forward, PE-owned companies may need to look at outsourcing as a way to access cutting-edge technologies and capabilities that can lead to revenue growth opportunities, in addition to reducing costs. And outsourcing is no longer a tool only for large companies; outsource providers are targeting mid-sized companies, too.

For example, an area such as real estate management may not contribute to a company's top line, or functions, like cybersecurity, may require more up-to-date expertise than can be managed in-house. These examples illustrate why, over the next several years, more PE-backed middle-market companies are likely to leverage outsourcing.

The solution: Companies of all sizes may need to continually assess where outsourcing can create value for stakeholders. Areas that are not core value-creating activities and those where the company lags in technology or cost efficiency can be strategic outsourcing candidates. Outsourcing can be a critical tool to help companies accelerate growth, access capabilities and reduce costs.

Summary

Traditional levers, including effective sourcing of third-party spend, strong cost management and lean manufacturing will continue delivering value for private equity investors. However, these tools may not be enough to generate top-tier returns in the future. ESG plays a larger role in every portfolio company’s value story and ability to generate growth long after their PE life cycle. PE professionals and management teams will likely need to attract the right talent at the right cost. While automation and outsourcing will be important tools for cutting costs and streamlining operations, they can be part of a coordinated strategy to access cutting-edge technologies and build scalable businesses. Automation and outsourcing in 2022 are much more than tools for reducing costs.

About this article

By Gregory Schooley

EY-Parthenon US Value Creation Leader; Principal, Ernst & Young LLP

Seasoned executive combining operational, M&A and strategy experience. Trusted advisor on critical business decisions. Passionate and proactive who values a healthy debate. Father and traveler.