Value creation ("Value Gen") isn’t easy right now. Average transaction multiples are at their highest level in 10 years. More and more prospective targets have already been through multiple rounds of PE ownership, with the “easy and obvious” value improvements already made. Fewer proprietary deals seem to exist.

Within that context, it helps to have a structured, repeatable framework to think about value gen opportunities. Here are three steps that we’ve seen some of the most successful acquirers and operators use to structure their thinking when building a value gen plan.

1. Business value drivers

To begin, we need to clearly identify the levers that can be pulled to make the business more valuable. Beyond simply increasing revenue and profitability (although those both help), these levers should ideally also create multiple expansion (i.e., they supercharge the impact of the growth and create a business that is worth even more).

The value levers will be unique to each opportunity, but some of the more common ones today include:

• Increasing recurring revenue (vs. one-off transactions)
• Reducing customer churn
• Lowering customer acquisition cost
• Identifying new revenue streams (particularly if they drive diversification or better margin profile)
• Radically increasing share of wallet (e.g., through bundling) – if it increases customer loyalty and reduces price sensitivity
• Winning with new customer segments that are more loyal, and/or less price sensitive
• Expansion within the value chain into new (and hopefully better) profit pools

We have a set of often overlooked value drivers that might provide useful food for thought – you can download the PDF.

2. Customer value drivers

Once we have a clear view of the business value drivers, the next step is to document the customer value drivers. The aim is to understand:

• What are our customers’ fundamental motivators & value drivers?
• How do we entice customers to shift their behaviour – in a way that aligns with the business value drivers?
• What (and how high) are the barriers to change? Is it feasible to overcome those within our hold period, given available resources?
• Which competitors (or alternative solutions) do we have to beat?

Depending on the value gen plan, the customers in question might include the current business customers, our competitors’ customers, or non-users.

Understanding the level of alignment and overlap between the business and the customer value drivers – based on a robust, voice of customer informed analysis – is critical to understanding the changes that we can effect, the pace of those changes, the level of investment required, and the probability of ultimate success.

3. Value structure

Once we own an asset, there will always be pressure to deliver margin improvement and increase free cash flow. One of the biggest risks is cost cutting to meet margin targets, and failure to invest against growth initiatives – cutting across the board and starving the growth plan of the resources it requires.

How often have you seen a portfolio company seemingly perform well for the first three years of ownership, but then fail to progress in the latter years of investment?

The ideal value structure takes learnings from the business value drivers and customer value drivers, and ensures that the company:

• Over-invests (i.e. radically differentiates from competition) in the areas that drive customer behaviour against the business value drivers - so as to create lasting competitive advantage and capabilities which deliver true customer loyalty and “wow”
• Minimises all other spend items (the “non-core costs”) so as to maintain profitability and free cash flow

Each step in this process may seem obvious, but in our experience, surprisingly few management teams have a holistic approach to addressing the opportunity. As in all systems, the value comes from having the complete picture, not just some of the piece parts.

Equally, thinking about the plan early – during the commercial due diligence process – is important to equip you to be a more effective owner and operator from the first days, and to ensure that your diligence is more than just a cursory examination of the business. Testing one or two hypotheses around the customer and business value drivers during diligence may give you the confidence to support today’s high valuations.

Copyright © GRAPH Strategy LLC