Private Equity (PE) has set an impressive track record over the last 15 years since the financial crisis. Prior to the financial crisis, the major driver of returns for PE was financial engineering and leverage. Spurned by regulation, competition, abundance of money supply and investor feedback, private equity has strived to create value through on the ground value enhancements.
Over the past decade, private equity firms have become exceedingly good at creating value in their portfolios. A significant element of this value creation is often an aggressive M&A strategy for add-ons. As we continue to navigate a challenging phase marked by higher interest rates, there will be more pressure on PE firms to continue margin expansion at portfolio companies by refining their service delivery models (SDMs) for key corporate functions (e.g., IT, Finance) and core functions (e.g., R&D, manufacturing, product/engineering). Determining the best SDM for each portfolio company requires understanding all current activities, the right model (e.g., onshore, near-shore, or offshore), planned capacity and key capabilities with four key steps:
- Identifying the company’s core competencies while formulating the deal thesis and value creation plan
- Understanding the scalability, capacity, and technology needed vs. its exit goals (e.g., 4X revenue growth)
- Developing the operating efficiency metrics needed to support the value creation plan
- Creating a SDM playbook to be rolled out against future add-ons to accelerate synergies
An effective SDM model allows portfolio companies to gain a competitive edge in terms of future synergy realization while also ensuring that they focus on their core competencies and leverage technological advancements (e.g., ERP, BI) effectively.
- Identify Portfolio Company’s Core Competencies: Review each portfolio company’s core competencies and identify areas that should be performed in-house vs outsourced. Based on assessing fundamental in-house needs, a portfolio company can determine which areas to invest in (e.g., FP&A, manufacturing, product development), which areas to outsource or offshore (e.g., AP, AR, QA testing) or automate repetitive tasks (e.g., expense approval).
- Scalability: As portfolio companies plan their growth, their service delivery models will need to scale accordingly. PE firms need to assess whether the existing service delivery model for their core and non-core competencies can support future acquisitions. Onshoring, offshoring, automation, and outsourcing plans for each function should be built with a multi-year horizon to provide portfolio companies with scalability and flexibility in response to changes in demand or market conditions.
- Technological Maturity: Assessing a portfolio company’s current technology infrastructure and assessing where key technological advancements (e.g., new ERP, data lake strategy) can benefit the portfolio company’s scalability and ability to easily incorporate new add-ons. Automation technologies, such as RP&A and AI/ML, can improve operational efficiency and quality of product or service.
- Operational efficiency: By mapping a portfolio company’s current cost by function against the key metrics in the value creation plan, PE firms can identify where improvements are needed and build a roadmap to achieve these metrics. For example, if a portfolio company’s finance costs are higher than industry benchmarks, portfolio company management can build a revised finance service delivery model, reflecting the service model/core competencies needed (e.g., outsourced), scalability and technologies needed to improve margins and achieve these metrics.
- Value creation: After finalizing the delivery model for each function, PE firms and portfolio companies can “product-ize” their SDM strategy into a playbook for future add-ons, allowing them to purchase portfolio companies with immediate revenue and cost synergy opportunities that can be easily assimilated into their SDM and create value.
How MorganFranklin Can Help
If your PE firm is struggling with identifying and/or implementing an effective Service Delivery Model within your portfolio companies, then having a trusted partner with significant SDM experience is essential. MorganFranklin’s private equity professionals, which includes former COO, CFOs and CROs, work with companies to design and execute Service Delivery Model opportunities that drive value to the portfolio company and PE firm.
