Rebalancing the Engagement
PE firms need to make organic growth the primary focus of their engagement with their portfolio companies, so that it’s not crowded out by attention to costs. One way to do this is to introduce the concept of headroom as a framework for thinking about the growth available in a market. Headroom is a simple concept: It is the market share that a company doesn’t have minus the market share it won’t get. This framework has the advantage of breaking down the growth challenge into two binary questions. First, there is the question about who the potential switchers are — the customers in the market that aren’t 100 percent loyal to a rival. Second, there is the question of what it would take to get these less-than-loyal customers to switch. These are the needs-offer gaps.
Headroom is particularly valuable as a tool for identifying organic growth opportunities in mature, highly competitive markets, which are the ones in which private equity firms’ portfolios companies often play. In many of these markets, there is no pixie dust that will triple or quadruple a portfolio company’s organic growth rate — but that may not be necessary. Some of these markets are so big that a two or three percentage-point increase in market share, courtesy of a headroom initiative, could mean a game changer in additional revenue growth. Coupled with an improved flow-through of profit, which most private equity–owned firms are adept at generating, such an improvement could make a big difference in the outcome of an investment. “If we had a company that had 2 percent to 3 percent growth, and we grew it to 5 percent, and then we managed the costs well, that might be enough to actually drive the business,” says KKR Capstone’s Nelson.
For many companies, the other valuable outcome of a headroom approach is that it exposes areas of activity that can’t produce growth (for example, activities aimed at customers who are too loyal to other providers). So it isn’t only the way a company’s best prospects light up as a result of a headroom analysis that is valuable: It’s also the way everything else gets grayed out.
At their best, headroom initiatives make companies much more coordinated. The companies’ strategic planners, customer research experts, sales staff, and product developers all know they must focus on the same things — the switchers and the needs-offer gaps.
Of course, headroom initiatives are only one example of how private equity firms can work with their portfolio companies to get them to think more explicitly about organic growth. Centerview Partners, for example, a private equity firm formed in 2006, relies on its focus and credibility to influence its management teams’ thinking and help those teams grow. Centerview invests in only a few companies at a time, all of them in consumer goods and services, and benefits from the clout that its trio of partners, including former Gillette chief executive James Kilts, have in that industry. It isn’t only the connections of Kilts and of Centerview’s other operating partner, Joseph Schena (a former VP at Nabisco and Kraft Foods), that help Centerview’s portfolio companies, such as Nielsen and Del Monte. It is also the partners’ extensive market experience and knowledge. “We are very focused on increasing our portfolio companies’ top lines, in part by helping them expand distribution and enter new channels,” says David Hooper, the partner who runs Centerview’s private equity business. Indeed, Hooper says, Centerview won’t invest if it senses the stakeholders with whom it will be partnering aren’t “open-minded to letting us help make a difference.”