Although not all private equity firms may yet recognize the focus on organic growth as their industry’s third major innovation, some have already been moving in this direction. “A lot of the guys I know [in PE firms] have been thinking about the growth and the strategy” of their portfolio companies, says Steven Neil Kaplan, the Neubauer Family Professor of Entrepreneurship and Finance at the University of Chicago’s Booth School of Business, singling out TPG, KKR, and Bain Capital. “They are all trying to [address] it in different ways.”
TPG is a good example of a private equity firm that’s leading the way. Like many other firms, TPG looks to its portfolio companies’ top executives, whether those it has inherited or those it has installed, to drive organic growth. However, its 60-person operations team includes experts in the areas of pricing and sales-force effectiveness, two disciplines that can have a big impact on revenues. In addition, the many TPG operations personnel whose backgrounds are in “lean” — an approach to reducing costs that focuses on process improvements, using customer benefits as the compass — occasionally help TPG’s portfolio companies grow, albeit indirectly.
For instance, after TPG bought a piece of Motorola’s semiconductor business, its operating group consulted with the new chip company’s R&D function, in hopes of getting its engineers to improve the efficiency of the product development process. By the time the improvement program was finished, TPG’s portfolio company, ON Semiconductor, had greatly reduced the time it took to bring a new product from conception to market — from 500 days to fewer than 250. “The important thing was that we didn’t have to actually be technically strong in semiconductor design,” says Dick Boyce, the partner who heads TPG’s operating group. “We had to have very strong process capability, which we do in product development. You sort of have to pick your spots.”
Indeed, one big caveat attached to the idea that private equity firms need to find ways to spur organic growth is that spotting a growth opportunity usually requires an innate grasp of how a specific group of customers in a particular industry behave, and what those customers want. “You don’t understand how to create value unless you deeply understand an industry,” the University of Chicago’s Kaplan says. Most private equity firms do organize themselves by so-called industry verticals (health, consumer, retail, and technology are some common ones), but the expertise in those verticals is primarily for purposes of sourcing and making deals. If a firm has operating personnel, they are typically positioned as generalists — which makes sense since private equity firms can’t predict which of their industry sectors are going to need help in any given year and which (from the perspective of operating-group involvement) may be dormant. As TPG’s Boyce puts it, “We have to be able to flex people across various sectors.”
The critical question for private equity firms, therefore, is how they can get better at engineering organic growth within their portfolio companies without changing their firm’s structure and limiting their flexibility. The answer is that they will need to do three things: add new growth capabilities, rebalance the engagement with their portfolio companies in favor of growth, and find ways to make growth net free.
Adding Growth Capabilities
Of course, it’s always best, and simplest, if one has capable, growth-oriented executives running a portfolio company and the divisions within it — but this ideal isn’t always met, given private equity’s predilection for investing in companies that are underperforming and not fully realizing their potential. (Moreover, when target companies do have first-rate management, that fact is usually reflected in the buyout price.) Where the right people aren’t already running, say, product development or marketing, private equity may need to provide external support for those functions.