This article originally appeared on Forbes.com.
Private equity funds have historically leaned heavily on a combination of cost cutting and multiple expansion to underwrite future value projections. But today's macroeconomic and competitive conditions challenge either approach. In most markets, slowing economic growth or the outright threat of recession suggests that multiples are more likely to retreat from current record highs than to expand even further. At the same time, the most obvious cost-cutting opportunities are typically baked into inflated asset prices or have already been captured by a previous PE owner.
What's typically not baked into the price is the ability to deliver profitable organic growth—and to do it quickly. As discussed in Bain & Company's Global Private Equity Report 2018, that involves focusing value-creation efforts on the top line and developing commercial excellence capabilities to help portfolio companies sharpen how they approach their chosen markets. Boosting revenues, especially in the face of economic headwinds, is unquestionably harder than improving a company's cost structure, because it often poses complex questions about which products to offer, how to price them effectively and how to optimize the sales effort. But accelerated top-line growth has the most powerful impact on exit multiples, which means that spotting growth opportunities early can help general partners bid for companies more confidently, generate more value post-acquisition and exit more easily.
Hard work, big payoff
Creating value by actively managing for top-line growth works because it lifts profit along with revenue, generating impressive momentum. In a business-to-business (B2B) setting, we typically see a 10% to 20% top-line acceleration, and a 10% to 15% uptick in earnings before interest, taxes, depreciation and amortization (EBITDA), when companies target multiple commercial capabilities—and even bigger benefits when they infuse digital. Our research also demonstrates that median return on investment is 20% to 30% higher when companies use a commercial acceleration program vs. simply improving costs.
Innumerable factors affect revenue growth, from the strength of the company's overall vision to the most basic frontline interactions. The sheer complexity of the issue is one reason that PE firms have tended not to focus much on the go-to-market model. There's often a perception that commercial acceleration is more art than science and that targeting these capabilities would take too long, be too risky, and require a deep change to culture and mindsets. By contrast, cost reduction is more straightforward and easily measured—you know what you're starting with, and you know where you'll end up if you execute a few tried-and-true efficiency strategies.
But firms that have developed the ability to spot deficiencies in a company's commercial operation find that it opens opportunities that might have been foreclosed to them previously. That's because many companies—especially in the B2B realm—have yet to reach full potential when it comes to turning an adequate commercial organization into an excellent one. In our research, around 60% of all companies say they haven't done a good job of focusing their value proposition on their most critical target accounts. Few companies invest in the kind of pricing capabilities that eliminate lost revenue and maximize EBITDA margins. Fewer still regularly zero-base their sales capacity and coverage to ensure that the company has ample resources aligned to the most valuable opportunities.
While solving these problems within an average holding period can appear daunting, the most effective firms break down the challenge into the elements of commercial excellence they can address quickly. In our experience, the most successful commercial excellence programs target their initiatives carefully.
The objective is to create a practical set of prioritized initiatives that can have significant impact and produce early wins. The list depends on each company's individual circumstances, but the low-hanging fruit often involves aligning the sell/serve model to where the value is, optimizing governance and strategy around pricing, addressing potential cross-selling opportunities or the retention model, and tweaking the portfolio of products or services to better align with customer needs. Longer-term issues—but still addressable in year one—include revisiting the salesforce culture, adjusting compensation and making sure the best people are focused on the biggest jobs.
Delivering results consistently will challenge PE firms that have relied on efficiency measures and market beta to drive multiple expansion. But by focusing on the nuts and bolts of commercial excellence, firms can develop relatively straightforward, repeatable strategies for diagnosing problems in diligence and quickly tackling them upon securing ownership, opening up a new set of viable targets among the large number of companies that underperform commercially. For a deeper dive into how top PE firms are winning through commercial excellence, download our 2018 report.
Bain & Company partners Mark Kovac, David Burns and Jason McLinn are members of the Commercial Excellence group within the firm's Customer Strategy & Marketing practice. Kovac is based in Dallas, while Burns and McLinn are based in Chicago.