For Private Equity investors, generating higher value in their portfolio companies has always been key to securing higher returns. But how have they historically achieved this? By focusing on two powerful levers: cost efficiency and revenue uplift.
Now, these two value creation clusters have been joined by a third: digital transformation. It’s a tool that offers the ability to turn a portfolio business – especially a non-technology company – into a data-driven one by leveraging proven technologies to create higher value.
My role involves daily interactions with Private Equity investors. And recently, I’ve seen them taking a more pragmatic approach to digital than they have in the past.
What does this approach involve? It has two main aspects. First, PE firms are increasingly looking to validate the investment thesis through a digital lens. Second, they’re investing in digital earlier in the deal lifecycle through a series of initiatives, drawing on the same data-driven value creation playbooks used by the world’s most valuable digital companies.
The technologies they’re deploying to do this are advanced but low-risk: the likes of data analytics, artificial intelligence (AI), and the internet of things (IoT), among others. And they’re finding that these technologies – especially when used in combination – can generate substantial returns within the typical PE holding period of five to seven years.
What does this rising focus on digital signify? In my view, we’re rapidly moving towards a world where PE buyers demand proof of digital execution – together with a clear data-driven roadmap showing how digitalisation will fuel ongoing value creation post-deal. That’s why PE firms are investing in digital initiatives earlier in the investment lifecycle, meaning they can reap the rewards of a productive digital flywheel by the time the holding period matures.
This same motivation applies even when a portfolio company is a ‘digital novice’. As the exit approaches, PE owners will often create a robust digital plan that any subsequent buyer can then implement. And to help realise the full digital potential of their portfolio companies, the more innovative PE houses have created the role of a digital operating partner, charged with identifying, planning, and driving the execution of high-impact digital initiatives alongside the investment team and portfolio company management.
It isn’t hard to see why PE investors are zeroing in on digital. Recent studies show that the majority of traditional companies that have successfully embarked on their digital transformation journey have a higher total shareholder return. Similarly, a data-driven PE portfolio company enterprise can command a premium multiple through an increased revenue and value generation upside, thanks to its higher ability to monetise data, develop data-driven products and services, improve operational efficiency and asset utilisation, and integrate digital add-ons and platforms.
There are many real-world examples of these advantages in action. Take the PE-backed gear manufacturing business based in Germany that’s now providing predictive maintenance services by combining IoT and AI with the latest-generation sensors embedded into industrial gearboxes. Or the PE-owned speciality chemicals business that’s using digital configure-price-quote (CPQ) software as the single source of pricing and product data, boosting customers’ loyalty and stickiness by ensuring they’re well informed on a product’s characteristics before buying it.
However, as with any transformation strategy, successful digitalisation of portfolio companies involves overcoming some significant challenges. An initial hurdle is ensuring a common understanding of what digital actually is: there’s a need for education and a strong alignment between the investment team, portfolio management, and portfolio company leadership to create a clear vision for how digital solutions will support the overall equity story.
A further major challenge is managing stakeholder expectations around the value of the impact and the timeline for the transformation.
It’s also essential to start digital initiatives early in the holding period so that the PE investment team has enough time to see results in the exit multiple. A critical factor in overcoming these obstacles is having a regular dialogue on performance and tracking it with strong governance, such as an executive steering committee that combines operational stakeholders with the company leadership.
In parallel, throughout the deal lifecycle, a series of important questions need to be addressed. Such as:
As PE firms tackle these questions, they often find it hard to know where to begin the digital transformation process in their portfolio companies, or how to write a digital plan for the next owner. In my experience, the starting point is to understand the six applicable key digital building blocks for achieving digital maturity in a PE firm’s portfolio businesses.
Successful digitalisation rests on the foundation of a robust and practicable digital strategy, which should be scalable across the portfolio company and aligned with the deal team and management. The strategy can underpin a transformative agenda encompassing the first 100 days and a year-one plan, enabling initiatives to be identified ranging from quick wins to opportunities for disruption.
Whether a portfolio company is a B2B or B2C business, it should have the ability to collect product and business data and enable automated customer interactions. If designed and deployed correctly, these interactions can improve customer and lead generation, optimise pricing, and personalise the customer experience.
Smarter products and services enabled by digital technologies are a great way to open up new revenue streams. To achieve this, portfolio companies need to understand that they are producers and sellers of data and insights that can boost growth by enabling new digital products and services.
In tandem with the use of data-driven insights to drive revenues, technologies such as data analytics, AI, and automation can also provide greater visibility to a portfolio company’s executive leadership on its business performance and help to optimise operational efficiency throughout intelligent workflows.
As technology innovation continues to accelerate, it’s critical for any business to keep its finger on the pulse of where digital and technology can take it in the future. This is especially important for PE investments, given the need to build and demonstrate value within the holding period.
A mission-critical aspect of digital transformation is a digital employee experience allied with the right skillsets and supplemented by a digital partner ecosystem that provides access to add-on capabilities across the value chain.
While keeping these six building-blocks firmly in view, it’s important that PE firms apply digital maturity playbooks and conduct regular digital maturity assessments at the portfolio company level, as well as cross-portfolio reviews and rankings to identify capability gaps and share best practices. The digital maturity assessments – which can be carried out by the digital operating partner or external advisers – should examine each portfolio company’s current initiatives and recommend improvements to existing projects and/or suggest more impactful ones.
A proven solution that can help PE firms do this is PwC’s proprietary Digital Opportunity and Maturity Assessment framework and tool. A powerful and customisable asset that includes more than 400 digital levers, the solution helps Operating Partners and portfolio companies identify the key value levers to accelerate their digital transformation, and map their digital maturity against their existing portfolio initiatives.
As technology continues to advance and the importance of digital transformation to value creation keeps rising, what lies ahead for PE firms? In my view, the key to success going forward will be to constantly connect with innovation and understand what early-stage technologies and businesses are disrupting the market.
With this in mind, I believe we’ll see PE investors take steps to boost their digital potential by entering partnerships or venture client relationships with tech companies, building digital ecosystems of suitable partners and suppliers, and co-executing digital initiatives such as process automation. These partnerships can play a vital role by enabling PE firms to share technologies broadly across their increasingly connected portfolios.
Beyond ecosystem building, I expect to see PE strategies increasingly using digital company add-ons to further strengthen the skills base available to their portfolio companies and accelerate their product innovation. Digitally mature portfolio companies are also better placed to acquire digital assets as the basis for deploying disruptive capabilities and platforms, further increasing their premium valuations.
The message? As all sectors of the economy race to embrace digital as a source of value, PE is at the forefront. And by applying a digital lens to their portfolio companies, firms stand to reap the benefits through higher multiples. The digital era in PE has truly arrived.
“The key to success going forward will be to constantly connect with innovation and understand what early-stage technologies and businesses are disrupting the market.”