Operational value enhancement in private equity portfolios
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.
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.
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. http://www.huz.de