3 questions to smart minds

Operational value enhancement in private equity portfolios

For this 3 questions to Dr. Joachim Dettmar

h&z Manage­ment Consul­ting AG
Photo: Joachim Dettmar
25. Novem­ber 2015

Now more than ever, private equity firms need to rethink their stra­te­gies for achie­ving their goals. The goal of acqui­ring a port­fo­lio company at a low price, putting it on a compe­ti­tive growth course and thus gene­ra­ting an above-average return for the inves­tors in the respec­tive fund, poses new chal­lenges for the private equity industry.

For this 3 ques­ti­ons to Part­ner at h&z Unter­neh­mens­be­ra­tung AG in Munich

1. Today, private equity inves­tors are less and less able to leverage the value of a port­fo­lio company with acqui­si­tion finan­cing. Instead, opera­tio­nal value enhance­ment poten­tial is requi­red. How can these be implemented?

The rising multi­ples are putting incre­asing pres­sure on the usual returns. Incre­asingly, advan­ced approa­ches to value gene­ra­tion are in demand. Our expe­ri­ence shows that signi­fi­cant poten­tial often lies dormant in this area, espe­ci­ally in the opera­ti­ons of medium-sized compa­nies. The reason for this is their gene­rally low level of matu­rity in the corpo­rate func­tions compared with many large corpo­ra­ti­ons. There is no stan­dard proce­dure for lever­aging this poten­tial in SMEs, because opera­tio­nal approa­ches to incre­asing value are always very company-speci­fic. The indi­vi­dual chal­lenges are not only in the proces­ses, but espe­ci­ally in the culture, the manage­ment style and also in the expe­ri­ence and beha­vior of the employees.

The realiza­tion of opera­tio­nal value enhance­ment poten­tial can only happen in coope­ra­tion with the opera­tio­nal manage­ment of the port­fo­lio compa­nies. The basis is the consen­sus between manage­ment and share­hol­ders on the scope and objec­ti­ves of the opera­tio­nal value enhance­ment initia­ti­ves. In the case of medium-sized compa­nies, a short and inten­sive analy­sis phase is usually carried out to deter­mine an over­view of the orga­niza­tion, essen­tial proces­ses and indi­ca­tive poten­tial for opti­miza­tion. In this phase, we review and struc­ture exis­ting data at h&z, e.g. key produc­tion figu­res, procu­re­ment volu­mes, exter­nal contracts, visit selec­ted produc­tion sites and conduct inter­views with func­tional mana­gers and manage­ment. Based on the infor­ma­tion gathe­red, we iden­tify initial approa­ches for opti­miza­tion. The decis­ion as to which speci­fic measu­res are to be taken is then made jointly with the manage­ment and, if neces­sary, the share­hol­der, after weig­hing up the costs and benefits.

Taking produc­tion as an exam­ple, this can mean that exter­nal produc­tion experts work with produc­tion staff to analyze problems such as high scrap rates. The expe­ri­ence of the exter­nal expert and his “view from the outside” make it easier to iden­tify the key levers and find suita­ble solu­ti­ons. In the area of purcha­sing, nego­tia­ti­ons with core suppli­ers are often prepared and conduc­ted jointly, with the exter­nal consul­tant provi­ding support in the form of nego­tia­tion exper­tise and expe­ri­ence. To the outside world, he usually takes on the role of the “bad guy.” Intern­ally, it helps to put estab­lished custo­mer-supplier rela­ti­onships to the test and suggests alternatives.

2. What does success in lever­aging value poten­tial depend on? In which areas do you see the grea­test poten­tial for companies?

Opera­tio­nal manage­ment must stand behind and actively support the plan­ned opera­tio­nal initia­ti­ves to increase value. This is true for opti­miza­ti­ons in a port­fo­lio company, and even more so for cross-port­fo­lio approa­ches. Each parti­ci­pa­ting company is requi­red to provide simi­lar levels of resour­ces, data, logi­sti­cal support, and commer­cial infor­ma­tion such as contracts, rates, and terms & condi­ti­ons to ensure the realiza­tion of poten­tial effi­ci­ently and with maxi­mum effect. This includes mutual trust and a willing­ness to share infor­ma­tion and work toge­ther. In addi­tion to the trans­pa­rent avai­la­bi­lity of infor­ma­tion, func­tio­ning colla­bo­ra­tion is the key success factor. The sustaina­bi­lity of joint and cross-port­fo­lio measu­res is ensu­red by invol­ving cross-func­tional part­ners, for exam­ple from product development.

Short-term success in reali­zing opera­tio­nal value enhance­ment poten­tial can usually be achie­ved in purcha­sing by renego­tia­ting or swit­ching suppli­ers for stan­dard products. Here, it is important to weigh up whether the short-term cost-cutting succes­ses can be offset by long-term disad­van­ta­ges in the area of quality. If you focus on those measu­res with the highest poten­tial for value enhance­ment and also break with “old tradi­ti­ons” such as “church-tower sourcing”, signi­fi­cant impro­ve­ments can be achie­ved in the bottom line. These can be further increased by cross-port­fo­lio measu­res: If procu­re­ment volu­mes are bund­led across seve­ral port­fo­lio compa­nies and jointly tende­red on the market, the econo­mies of scale usually lead to impro­ved condi­ti­ons. These jointly achie­ved condi­ti­ons are trans­la­ted into indi­vi­dual contracts with the parti­ci­pa­ting port­fo­lio compa­nies at the end and thus conti­nue to apply even after a possi­ble sale of the company.

Measu­res in the area of produc­tion, such as the intro­duc­tion of “Total Produc­tive Main­ten­ance” with the aim of redu­cing down­ti­mes, are also promi­sing. Quality circles can be simi­larly successful in streng­thening the CIP (conti­nuous impro­ve­ment process) and making more inten­sive use of employees’ idea poten­tial. In addi­tion, there is poten­tial for opti­miza­tion in various medium-term measu­res. Design-to-cost initia­ti­ves, for exam­ple, can reduce mate­rial usage as well as manu­fac­tu­ring and assem­bly costs. In addi­tion, other important levers for opti­mi­zing costs lie in the supply chain. Impro­ved fore­cas­ting and opti­miza­tion of produc­tion plan­ning, for exam­ple, help to reduce freight costs by redu­cing the number of special freight ship­ments. And freight costs them­sel­ves can in turn be redu­ced by means of tenders and route optimization.

3. How are the private equity houses deal­ing with this? Are they now also buil­ding up inter­nal knowledge?

We do not see a consis­tent picture here. On the one hand, there are the clas­sic growth funds whose primary focus is on incre­asing sales. On the other hand, we see private equity houses that alre­ady focus on value crea­tion “below the line” via “opera­ting part­ners” or “opera­ting teams”. Aware­ness of the need for opera­tio­nal action is incre­asing. A good exam­ple is EQT, which last year estab­lished two opera­ting part­ners to become more operational.

In this respect, private equity houses do not neces­s­a­rily build up detailed know­ledge of opera­tio­nal topics in-house, but rather streng­then their assess­ment compe­tence in order to select exter­nal service provi­ders such as manage­ment consul­tants or specia­lists and assess their perfor­mance. Usually, diffe­rent provi­ders are tested in diffe­rent areas under initi­ally close super­vi­sion in small pilot projects. If a fruitful coope­ra­tion with the manage­ment of the port­fo­lio company and the opera­ting part­ner of the private equity house succeeds and is accom­pa­nied by an increase in value in line with targets, further contracts are awarded. Know­ledge is thus trans­fer­red from exter­nal consul­tants to the employees of the port­fo­lio company. In our expe­ri­ence, consul­tants are successful here who do not only proceed top-down, but rather under­stand how to imple­ment the opera­tio­nal measu­res for value enhance­ment toge­ther with the manage­ment and the employees, combi­ned with know-how trans­fers (also through trai­ning). This is a new aspect for the private equity indus­try, which has been used to working with consul­tancies that take a purely top-down approach to due dili­gence activities.

About Dr. Joachim Dettmar

Dr. Joachim Dett­mar is a part­ner at h&z and an expert in market stra­tegy issues. His focus is on busi­ness stra­tegy, holi­stic opti­miza­tion and bench­mar­king. In addi­tion to projects in the corpo­rate envi­ron­ment, he supports private equity clients and their port­fo­lio compa­nies at h&z, for exam­ple in due dili­gence and port­fo­lio opti­miza­tion issues. Further­more, he deve­lops the coope­ra­ti­ons and the busi­ness deve­lo­p­ment of h&z in the Asian market toge­ther with the part­ner compa­nies NRI and Fidu­cia Manage­ment Consul­tants. From expe­ri­ence, he knows how important it is in inter­na­tio­nal projects to coope­rate with locally rooted compa­nies in order to compre­hen­si­vely take regio­nal condi­ti­ons into account and successfully deal with inter­cul­tu­ral chal­lenges. He has been in manage­ment consul­ting for ten years.

About H & Z Manage­ment Consulting

Charac­te­ristic and guiding for h&z is the prin­ci­ple of part­ner­ship-based manage­ment. This includes flat hier­ar­chies and team­work, as well as the philo­so­phy: consul­ting with brain, heart and hand. h&z combi­nes clas­sic approa­ches to busi­ness opti­miza­tion (busi­ness excel­lence) with an under­stan­ding of the client’s speci­fic corpo­rate culture. Thus, the manage­ment consul­tancy is convin­cing in the central tran­si­tion from stra­te­gic consul­ting to opera­tive imple­men­ta­tion support. With its deep under­stan­ding of busi­ness trans­for­ma­tion proces­ses, h&z supports the deve­lo­p­ment of a perfor­mance culture in the company.

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