Focus on upside lessons from the private equity

All parts of a business must be looked at thoroughly in order to calculate its full potential

To negate this common and often expensive problem, businesses can learn from private equity (PE) investors when planning their transformation initiatives and apply a proven PE approach to delivering outstanding results.

By Ross Macallister - Managing partner Head of Consulting KPMG Vietnam & Cambodia

There are many reasons why a PE investor might look to fund a particular business, including the potential for revenue growth and good cash flow generation. However, one of the key factors that drives investment decisions for PE is the potential to extract upside value from a business through affecting operational improvements.

One of my observations is that their model is underpinned by its capacity to identify value upside or the “what to do’s”. This skill helps answer the most important questions for them, namely whether or not they should fund a business and, if so, how much they should pay for it.

Having a focus on these questions that add value and then putting in place an appropriate strategy or programme of change to deliver the value is essential to avoiding transformation failure.

The understanding of how a PE investor goes about identifying what they need to do to enhance and extract value provides excellent insight that can be applied across any business to increase its chances of delivering the expected value from its transformation initiatives.

Those familiar with the world of mergers and acquisitions will be well aware of the limitations placed during the transaction process. As a buyer, you do not have months to spend in analysis – the seller is unlikely to give you that much time to get completely comfortable with what you’re buying. In addition, you will not have that much access to the target’s management team or data so you do not have the ability to get into a lot of detail.

PE firms are typically good at working around these limitations because, to have an advantage when bidding against, for example, a corporate buyer who often has synergy benefits that a PE buyer will not have, the buyer must be highly adept at finding hidden value in a transaction.

As such, typically a PE buyer focuses on ensuring that they know what they need to do to deliver value. They have a plan to accelerate delivery and build a results-oriented mindset, and they make the most of the experience, knowledge, and talent that exists within the target’s management.

The factors involved

There are four principles that summarise how to approach value identification similar to a PE buyer as part of transformation initiatives. The first is to base it on hard facts. It should be data driven which helps your management team to hold an objective mirror up to itself, and this can only work if the process is based on facts.

The second principle is using comparators. This can be very different from competitors. Looking at what companies in your industry are doing is still important, but recognise that comparing yourself to companies from other industries often shows you alternative, potentially superior ways of operating which may not be the norm in your own industry. The key is understanding how other businesses achieve a particular outcome, and not simply the outcome itself.

The third principle is staying focused on speed. Getting to an 80 per cent correct answer is good enough as the remaining 20 per cent is probably going to take longer. Remember that they are making large decisions here. When determining how much to pay based on the upside they see in a business, they are paying for that upside upfront and in full.

The last principle is to understand the risks. It is necessary to place special emphasis on the importance of understanding the potential risks as well as value to provide a balanced view of the portfolio of available opportunities.

This approach helps build stakeholder engagement through a common language of financial outcomes which everyone understands.

In a nutshell, the aim is to take an unconstrained view of the potential of the business by using a top-down, 80/20 approach to value identification, and leveraging facts and experience from outside the business to stretch thinking into exactly what is possible within the business.

The above approach begins with opportunity identification, or a diagnosis, looking at the business from the outside in, to identify what the full potential of the business is.

Once this has been achieved, they can then explore potential solutions to understand how exactly the opportunity could be made to work in the business, and what the plan is to deliver benefits. Also, a key piece of work typically done at this stage is to understand what would stop the opportunity from being realised.

The final piece of the puzzle is to ensure that benefits are delivered in full and in a sustainable manner.

One of the things that contributes to the success of this approach is the way that the involvement of the business increases towards implementation. I have seen many instances where management teams have been turned from being sceptics into real believers by the power of using their own data to prove an opportunity and then working with an external advisor to deliver it.

Organise and analyse

So, start with a baseline of your business’ financials and organisation, so that you are truly grounded with a comprehensive up-to-date understanding of your business. For example, you may be surprised how many businesses have no idea of how much human effort it takes to run their company. They fail to realise that all those contractors they have maintaining their assets, all those call centre operators they have in far-flung parts of the world, all those people are really part of their true headcount despite the fact that they are not on the payroll.

Secondly, analyse data from the business to build a body of operational evidence. Again, our clients are often amazed at how much insight can be gained from a seemingly unconnected mass of data. A good example is a client who had significant issues in delivering growth projects. When analysing its internal projects data, it was shown that the business was spending a lot of time on non-critical, non-margin generating integrity management projects at the expense of its growth projects. This analysis gave management insight into why the business was not delivering on its growth ­projects.

Thirdly, and this is very important, make sure that you triangulate your thinking by using comparator data that is tailored and relevant to the business. Here, KPMG’s global reach and investment in capabilities gives us unique insight into almost every aspect of a business’ activities. Note that this does not have to be external data – take the example of a business that has global operations which have very different levels of performance between assets. The amount of comparator data that we have been able to get from within their own asset portfolio alone has been tremendous. When you put all these together, you end up seeing a really strong case that proves an opportunity ­exists.

Finally, focus on how the opportunity will work and what the plan is to deliver the benefits from it. Challenging your own assumptions is key here, and where possible, get an external validation of your thinking and then socialise widely to ensure there is a thorough understanding of the opportunity, and a shared alignment on how the benefits will be accrued across all the stakeholder groups.

Once this is carried out, the focus is on developing high-level plans with three things: an identified opportunity owner, a governance structure, and a benefit tracking mechanism. Opportunity ownership drives accountability, and benefit tracking and robust governance ­improves sustainability of change.

Achieving sustainable value improvement from your transformation is not just about identifying and driving delivery of specific improvement initiatives. It is also about setting the ­business up to focus on ­performance and further ­improvement as a normal, everyday part of the way it operates.

The key to this is recognising that changing behaviours and culture can often be the most difficult challenge of all. To mitigate this risk, it is essential to develop an approach and a set of tools to help understand and address the issues associated with managing change in a transformation initiative. Getting this right underpins the delivery of sustainable value and will result in long-lasting transformational success.