Best Practices in Operational Improvement for PE-Backed Platform Companies

The PE-Backed Executives Group and TheOperators.pe recently hosted a discussion of Operational Improvement Best Practices. This article reveals some of the agreed upon perspectives of the Operators and one private equity professional in attendance for discussions on Friday, June 2, 2023.

Since Operational Improvement can be a significant source of value creation, and yet is also the subject of significant debate in terms of where to focus, it makes sense to establish some commonly agreed upon principles.

As a first step, it makes sense to take into consideration the situational peculiarities of the platform investment (is it a turnaround situation? was it a founder-led organization, or is it in the fourth generation of PE-ownership?).

In other words, the context of the portfolio company’s situation dictates much in terms of how to approach operational improvement.

In addition, the Group of C-level operators who participated in our discussion agreed that the starting point is the Private Equity Owner’s Investment Thesis. And to be even more specific, what is critically important is the mindset, perspective, assumptions, and priorities of the deal team members who sit on the board, plus the Operating partners who are involved (rather than the minutia of the sub-tenets of the thesis, per se). Said another way, pay attention to your Board’s perspective more so than anything else when establishing priorities for operational improvement.

Indeed, there are three perspectives at play (the management team’s, the PE deal team’s, and the PE operations team’s). Ideally, their perspectives are aligned. Chances are, however, they are not. In many cases, the misalignments, misunderstandings, confusing reporting structures, lack of transparency, and ego battles trump the specific details of where to focus for operational improvement. In other words, focus on establishing and maintaining alignment and agreement because all subsequent efforts to ensure operational improvement without this alignment in place may be for nought.

It can be difficult to ensure alignment of intent, interests, mindset, expectations and value creation priorities. In some cases, ego, need for respect and attitude get in the way. In other cases, past experience and judgment, or even recent experience or lessons learned, even very recent diligence discoveries, impact the ability of these stakeholders to agree on focal areas for operational improvement.

Operational Improvement should begin with agreement, alignment on expectations, focal areas and performance metrics.

Operational improvement does not begin with the results of diligence or with a 100 Day Plan or a Value Creation plan. Think of due diligence as the responsible efforts to discover potential problems, albeit in an adversarial environment (management vs. deal team), with timing pressures, and the acknowledgement that some discoveries made by diligence teams reveal problems that are relatively insignificant while other major concerns go undetected. It is the nature of acquisitions – there will always be an elephant in the room, a problem that has yet to reveal itself. Discovering it is sometimes difficult and time consuming.

Inevitably, despite best efforts to assess and understand weaknesses or operational inefficiencies, time and experience will reveal new data that demonstrate higher priorities than originally assumed. It is important to allow the value creation plan to evolve and grow and transform as discoveries are made.

Defining and Gaining Alignment Across All Stakeholders.

As important for the management team as for the Board, define the strategic intent and positioning, the objective or future Vision of the business. What is the stated Goal of the business, why is it important, how will it be achieved, when will it be achieved, what are the impediments, how will they be removed and who will do what tasks to make it happen.

Calibrate your perceptions of "feasible" 100 Day plan with the Board's views of priorities for the business, and their expectations.

While the Path must be navigable, it may be more useful to think about a mutually-agreed-upon definition of the End Point, the Exit Strategy, and make course corrections along the way, with the end point clearly in mind. In other words, maintain an understanding of weaknesses and threats as well as an open mind to all potential levers for value creation, including internal levers such as financial (potential profit or balance-sheet improvements, working-capital optimization), human capital, product/service innovation, or External Levers such as customer positioning, partnerships, supplier relationships, competitive dynamics, market opportunities, M&A opportunities. Executives brought in to run a newly acquired portfolio company must simultaneously manage, measure and scale the business.

Several experienced Operators noted that it is important to socialize false assumptions and weaknesses, hurdles and impediments early, but to have in place feasible work-arounds, next-step solutions, or at least new ways of thinking about how to achieve the exit plan. In other words, do not simply be the bearer of bad news; have a plan to revise the value creation strategy.

Assessing.

Conduct assessments of the business in order to identify weaknesses and vulnerabilities, areas on which to focus for needed improvements. The assessments, across functional areas, aid in determining what to prioritize in order to ensure value creation.

Assessments should result in an understanding of costs and time required to facilitate improvement, and more importantly, to execute value creation transformation steps. Incumbent in this process is an understanding of which projects will provide the most substantial and most immediate return.

Prioritizing. Assess potential operational improvements as early as possible.

While no list can possibly be all inclusive, the below are intended to be thought provokers to help you think about your portfolio company and its potential needs for improvement. There are 31 suggestions below. However, they are not necessarily in priority order for your business, and it should be obvious to experienced executives that you will be more successful focusing on one lever rather than many or all of the list below:

  1. Integration of recent acquisition
  2. Factory closure/relocation
  3. Change manufacturing process
  4. Lean manufacturing
  5. Waste reduction
  6. Energy use reduction
  7. Offshoring/inshoring/outsourcing
  8. Retain high-performing personnel
  9. Governance and reporting
  10. SG&A Overhead reduction
  11. Supply chain optimization
  12. Purchasing cost reduction
  13. Working capital optimization
  14. Pricing strategy
  15. Channel strategy
  16. Sales strategy, effectiveness and cross-selling
  17. Marketing strategy
  18. Customer strategy, relationships, unmet needs, loyalty
  19. Distribution/logistics optimization
  20. IT systems improvement
  21. Property sale
  22. Insurance, tax measures
  23. Financial reporting, measuring and business intelligence
  24. Processes and technologies that drive major costs.
  25. Causes, drivers of rework
  26. Causes, drivers of inefficiencies and flow
  27. Sourcing weaknesses
  28. SG&A spend
  29. Inventory optimization
  30. Data-driven decision making — business intelligence tools, dashboards and analytics to support not only financial decisions, but strategic and operational decisions, as well
  31. Silos in decision making and reporting/responsibility, accountability, consulting, informing inefficiencies or disconnects

Evaluate potential levers for prioritization.

In order to prioritize, evaluate each of the potential operational improvements that you are considering in a decision matrix, in which you compare each potential improvement against the following factors.

  • Potential impact on valuation
  • Complexity
  • Risk
  • Resources/cost/people
  • Time required and timing concerns
  • Possible unintended consequences
  • Goals alignment

Conclusion

Operational improvement is complicated enough, simply taking the words at face value; however, because of the personalities involved, their predispositions, prior experiences, preferences, pre-judgments, and egos involved, the concept of Operational improvement in private equity can be quite an understaking. View operational improvement not in a literal “problem fix” mindset, but with an attitude of collaboration and humility in carefully arriving at one, or perhaps three agreed-upon priorities. It may be more difficult to arrive at consensus on where to focus, than on the actual operational improvement itself.

Additionally, bear in mind that over time, new/different problems will inevitably arise, so the exercise is essentially continuous. By the end of the First 100 Days, management will have a much clearer understanding of where to focus, why, and how they are being held accountable. Most experienced Operators agree that the single most important area of the business to “get right” in the first 100 days is human capital alignment. As we know, culture trumps strategy, and the right people in the right places doing the right things can fix just about any defect in functional areas of the business.

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