How private equity firms are creating value through digital transformation

To attract new capital, private equity professionals often emphasise their firm’s operational excellence, focusing on operations-related improvement initiatives, their portfolio companies’ corporate governance mechanisms, culture, organisation, and long-term objectives. However, with the increased competition of more than 8,000 private equity firms worldwide, does this continue to provide a competitive advantage in the marketplace?

According to Preqin – the leading provider of financial data and information on the alternative assets market – private equity buyouts reached an all-time peak of 5,106 deals globally, with an aggregate value of US$456 billion in 2018. With this record buyout activity at historically high valuations, it is obvious that private equity managers face significant pressure to identify new opportunities and operational angles to continue to deliver good risk-adjusted returns.

In response, many private equity firms have set up dedicated in-house operational value-creation teams. Yet, they are struggling to articulate exactly how these teams can add value to portfolio companies, and what differentiates them from their competitors. A small set of private equity fund managers have found an answer: they have decided to place digital transformation at the core of their operational toolkit.

Digital transformation

Digital transformation involves using a combination of new technologies and methodologies, including big data analytics, high-performance computing, artificial intelligence (AI), machine learning, the internet of things, blockchain, cloud solutions, internet connectivity, mobility or robust cybersecurity. These innovations are a huge leap forward compared to the Excel spreadsheets that most private equity firms use.

Digital transformation leverages the large amounts of data generated by portfolio companies and private equity firms. It could be one of the greatest untapped sources of additional profit. Most importantly, it holds the promise of more objective decision-making, a critical advantage when markets are volatile.

Digitalisation of portfolio companies

Private equity firms should start thinking about digitalisation at the investment due diligence stage where they can ask critical questions. As recently highlighted in a report by PwC, using the target company’s business model, private equity firms can investigate if it:

• provides digitally enabled products and services that collect valuable data
• helps with customer targeting
• develops new products and services. If so, are these co-created with customers, suppliers or partners?

Co-creation leads to faster product development and more innovation, as the company is more responsive to customers’ demands. On the production side, private equity firms can investigate whether tenders and supplier evaluations are automated and constantly evaluated. They can also see whether production processes are integrated to provide real-time visibility of ongoing production, and whether it is digitalised to identify bottlenecks and optimise workflows. On the logistics side, private equity firms can investigate if companies trace supplies electronically to lower inventory levels and optimise working capital needs.

Digitalisation provides even greater benefits for interactions with customers. Digitalisation can support and track customer satisfaction or facilitate omnichannel sales and personalised marketing. Due diligence can also assess whether the company’s accounting department can provide tailored and fast financial reporting. The rapid, automated analysis of financial data can allow private equity fund managers to judge the feasibility and likely profitability of new products and business models that the target company aims to promote.