Digital value creation opportunities abound in Private Equity portfolio companies. Whether value is created through technology-driven efficiencies, cost out of expensive tech departments, or revenue growth enabled by new digital products, digital can make a significant contribution to EBITDA as part of an overall investment case.
On the other hand, the excitement of creating value can often overshadow essential, digital value protection initiatives, which ensure portfolio companies manage business risks and secure existing value. These investments can range from the mitigation of value erosion, which can occur when old technology fails and has a significant impact to operations and customer experience. Even more significant can be the near existential risk that cyber attacks can pose to almost any company. A company's cyber protection can often be sub-standard, and value protection investments are necessary to mitigate the risk.
The dilemma in value creation vs value protection investment
Whilst both value-based investments can have a clear business justification, portfolio companies frequently find themselves unable to prioritise effectively when allocating limited enterprise resources of funding, people, and/or time. We often see an over-simplistic approach:
- 'A bird in the hand is worth two in the
bush' – an event (e.g. a customer-impacting
systems outage) or general anxiety (e.g. caused by a cyber
assessment report) results in a knee-jerk reaction and value
protection receives a blanket priority, restricting the digital
contribution to value creation.
- 'Our existing estate will be fine, let's focus on new opportunities' – value protection is ignored, applying the rationale that your existing business and tech will continue to perform as it has done in the past. The focus is then on, for example, cost-out via automation technology or revenue growth through an advanced analytics capability for customer sentiment analysis.
Is there a smarter way?
We have identified three key principles to manage the prioritisation of investment in digital within portfolio companies:
- Get out in front of any problems –
The earlier you are sighted on technology-related risks, the better
able you are to make informed investment decisions. If you've
identified technology-related risk in diligence, you can negotiate
the necessary value protection investment into your acquisition
price. This way you may be able to afford to do both value
protection and value creation investments.
- Look for the win-win – There are investments that offer both value creation and value protection opportunities. If you are consolidating several existing applications onto a new platform, you can reduce operational and cyber risk with more modern technology whilst realising cost synergies and delivering new capabilities that might attract new customers and associated revenue. The upper right quartile opportunities (on the figure below) are fantastic investment opportunities.
- Make data-driven decisions – The
two principles above try to avoid the key dilemma, but this only
gets you so far. Even if you've planned value protection into a
reduced purchase price and identified some top-quartile digital
opportunities, you will end up looking at the dilemma of value
creation vs. value protection once the low-hanging fruit has been
picked. The key is to have a strong set of data on your digital
systems to inform prioritisation:
- Model your digital estate – we use
tools to create a 'digital twin' model of each component of
technology in a company's value chain. Age of technology, level
of cyber protection, what revenue the technology supports,
alongside the cost of the technology are all key data items to
model.
- Protect your crown jewels – With
good granularity in data and a model you can cut in many
dimensions, you can identify those systems in the value chain that
support the highest levels of revenue and their relative risk.
Focus your value protection investment there.
- Truly understand the EBITDA impact of your value creation opportunities – With a true understanding of your digital estate and its economics, any value creation opportunities can be directly translated to true EBITDA impact and therefore prioritised accordingly.
- Model your digital estate – we use
tools to create a 'digital twin' model of each component of
technology in a company's value chain. Age of technology, level
of cyber protection, what revenue the technology supports,
alongside the cost of the technology are all key data items to
model.
Digital and technology are often shrouded in mystery and complexity with business cases that are unclear, scare tactics that are unjustified, and jargon substituted for proper data-driven decision making. However, with the right tools, capabilities, approach – and backed with the right data – you can better understand the technology around you to make more informed investment decisions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
