Digital disruption: Private equity's secret weapon for unlocking portfolio value creation

Competitive pressure in private equity hasn’t eased in 2023—and it’s coming at all stages of the deal lifecycle. We’re seeing established firms and new entrants alike competing for a limited number of quality investments—that means potential deals with solid, risk-adjusted value opportunities. It’s forcing companies to be more aggressive with their bids, adding additional pressure to unlock value at portfolio companies prior to exit.  

Successfully creating value and improving exit multiples requires investment—and private equity firms are increasingly investing in digital and data as a value driver. Digital enhancements are a proven method for driving higher EBITDA, and most private equity investors agree: 82% of respondents to West Monroe’s Digital at the Speed of Private Equity report agreed. 

So then, how do you make impactful digital improvements in an environment that is extremely cash-conscious and risk averse? We interviewed private equity industry leaders to gain insights about that very question.  

Firms are moving away from high-cost, high-risk efforts 

A common thread throughout the interviews was that private equity investors and management teams have little appetite for investments in which ROI won’t be realized in the short term or medium term.  

Take ERP implementation for example: These large-scale transformation projects are typically viewed as foundational investment for scalability—but costly and time-intensive both to implement and to showcase ROI. While these may still be valuable initiatives to undertake, their higher risk and more elongated timelines make private equity management teams and investors uneasy given the current market environment. 

The key is realizing that digital value creation is not always synonymous with a full-blown transformation. Instead of thinking in terms of large-scale initiatives to overhaul every aspect of a portfolio company, now is the time for strategic precision. Start by identifying quick-win use cases and prioritizing time and resources—done properly, this ensures maximum return while also reducing risk. 

It involves analyzing available internal, external and PE proprietary data to determine specific points in a client’s value chain where digital enhancements would add the most value. Analysis should begin with a value-oriented approach to tech/digital diligence while a target is being evaluated and continue into the hold period. West Monroe data shows that this approach is becoming more commonplace, with 63% of private equity firms stating their priority for tech diligence is or should be value creation and not risk mitigation. 

Note, however, that data analysis should be a fundamental component throughout the digital transformation process to benchmark progress and track results—not just to identify areas for value creation. As we discussed in West Monroe’s 2023 Private Equity Industry Outlook, the private equity firms standing out among their competitors are the ones whose digital value creation plans are driven by data and analysis throughout the entire deal lifecycle. 

Value identification and use case identification  

The goals of any digital enhancement vary depending on who you ask. While your customer experience team may be focused on impact to the end user, someone behind the scenes might prioritize overall operational efficiency. At its core, however, all digital investments should either bend the revenue curve up or reduce the costs to deliver that revenue. 

The specific value creation levers that private equity firms pull will vary based on the priorities identified during diligence—and these levers could certainly change throughout the hold period.  

The potential levers each have the potential to add value through digital enhancement; this includes collecting better data, finding more efficient and effective ways to use data, and positively impacting the experiences of key stakeholders. These don’t need to be all-or-nothing decisions, either—digital investment in each of these areas could be scaled up or down based on priority and availability of resources. 

Revenue growth: Customer preferences continue to shift toward more digital-heavy interactions and experiences, and digital enablement is key for converting and retaining customers. Enhanced data analysis provides new opportunities for targeting and engaging with prospective and existing customers, helping to ensure that the right products are being placed in front of the right people for a higher ROI. 

Cost optimization: Reviewing processes and procedures through a digital lens presents an opportunity to optimize costs and deliver services more efficiently. This includes using data analytics to identify common components in product offerings to reduce material costs, implementing automation tools to decrease administrative efforts and manual tasks, or integrating cloud solutions to lower infrastructure costs, reduce maintenance costs, and improve scalability. 

Talent management: It’s not enough to develop the right processes. Revenue generation and cost reduction will be incumbent on having the right talent in place. Given labor shortages and changing labor expectations, talent-focused digital investment can also include streamlined recruiting processes and new opportunities for upskilling current employees. Additionally, developing a more analytics-based approach to staffing and utilization can help ensure employees are focused on high-value work and can uncover additional opportunities to introduce automation. 

Risk mitigation: Cybersecurity poses a variety of threats to a portfolio company, including disruption of services and data theft. These threaten not only a company’s operations but also customer trust and loyalty. Risk mitigation should begin during diligence and remain a priority until exit to ensure nothing holds up the eventual sale of a portfolio company. Digital strategies for risk mitigation include using data to detect cybersecurity vulnerabilities and monitor fraudulent activity, as well as leveraging machine learning/AI to identify suspicious behavior patterns. This may also include SOC2 and other compliance auditing to protect portfolio companies when partnering with vendors and other companies.  

Using data to enhance your value

People often think about digital transformation in terms of where new technology and tools can be implemented. But these tools aren’t the end goal—they should be done in parallel with the data strategy given the value of data as an asset. Digitally enabled businesses run on comprehensive data and the actionable insights that can be gleaned from it.  

Investing in digital solutions that increase the amount and quality of data a company has access to enables go-forward behaviors that are grounded in firm facts. 

Every lever a private equity firm can pull to create value at a portfolio company has the potential to be enhanced through thorough data analysis. Data is the key to unlocking revenue opportunities, reducing costs, and expanding margins. 

Conclusion

The era of low interest rates and sky-high valuations is over—and the jury is still out on whether or not it’ll ever return. While we leave that debate to the economists, we can focus on what to do in the meantime: a stringent focus on smaller, more meaningful digital investments.