The Competitive Advantage of Digital Transformation
Tech like the Internet of Things and data science can be a challenge, but it's manageable with the right experience and development partners.
Digital transformation is the operational transformation of a traditional company into a digital-traditional company. The digital operating partner uses high technology such as the internet of things and data science such as analytics, AI and machine learning to deliver digital initiatives designed to increase enterprise value.
Digital transformation is hard, but it’s due to reasons that may seem counterintuitive.
Tech such as Internet of Things (IoT) and data science is on the cutting edge, so of course it’s a challenge, but tech is a manageable challenge with the right experience and development partners. It’s not really the hardware or the software that presents the biggest undertaking; it’s the wetware. As in any operational transformation, it’s the human element that presents the biggest risk.
That said, experience has shown that when employees are in the right environment, this risk can be mitigated.
What Is the Right Environment?
Defining a digital transformation strategy and creating an internal digital team to execute it implies top-down decisions. But in most corporates, just the opposite occurs.
Ideas for digital projects mostly come from engineering. Sometimes this can be great, but more often than not, engineering-driven digital initiatives are about the tech—the shiniest bells and the clearest whistles that are supercool technology but not so cool from an investment impact perspective. Experience has shown that without the right leadership and culture, digital initiatives will pop up in labs without business plans, consuming precious opportunity cost, only to be stillborn because the projects weren’t valuable enough to raise the internal funds necessary to go commercial.
Transformation implies change and portfolio companies have a built-in platform for change—change is the reason private equity made the investment in the first place. Without change there is no new alpha, and new alpha is the difference between a good exit and a top-quartile exit. Suffice it to say, private portfolio companies are meant to change, and if digital transformation is part of the investment thesis, then the impetus for digital change will come from the top down, through ownership, board and then management.
Experience has shown that without CEO and C-suite support, digital transformation will never see the light of commercialization. Corporates with long-term CEOs and boards tend to have a lower sense of urgency and a “current-state” bias. This means they prefer to stay the course and make incremental changes rather than transformational ones, even if those hard decisions are what’s right for the company. If digital transformation is part of the investment thesis, PE investors will ensure the current management team is ready and capable of making changes quickly, or adjustments will be made. Once the right team is in place, the compensation models will be structured to be tightly aligned with the value creation plans of ownership.
Ownership Structure As A Competitive Edge
The buyout portfolio company has the environment most conducive to digital transformation success—better than strategics, private or public. This is a big deal. One that represents a significant competitive advantage for the company and its owners.
The LBO firm with the appetite and ability to apply digital transformation within its portfolio companies has a competitive advantage over other LBO firms. It is the inevitability of digital within all sectors that makes digitally transformed companies so attractive to strategics. Because of this, LBO firms with digital chops will, on the whole, have more attractive assets, which ultimately leads to better-performing funds. On the buy side, more targets look attractive because digital transformation is well suited to be applied to assets in the secondary buyout market. No matter how well run the company, further value can be created with digital transformation, assuming the right company attributes.
A Platform For Change
Digital transformation is a new and powerful tool to create enterprise value in portfolio companies. Since the technology used is the same for every company, all things being equal, it’s the nontechnical factors such as the ability to rapidly make changes and align resources that make the difference in digital transformation success.
It’s simple arithmetic. Having a platform for change, plus effective decision making, less distractions, plus a fit with the owner’s operating model adds up to LBO portfolio companies having the best ownership structure for digital transformation.
Bruce Sinclair is the author of The Private Equity Digital Operating Partner: Using Digital Transformation for Value Creation.
