Private Equity and Digitization: Creating Value by self-funding the digitization process
Digitization: the next source of company Value
Even before the pandemic, 92 percent of companies surveyed by McKinsey believed their business models would have to change given rates of digitization at the time. Covid-19 has only accelerated that timeline, with estimates indicating we’ve moved three to four years forward in digital adoption in a matter of months.
For Private Equity digitization may be the next gem of Value. Digitization can enable portfolio companies to compete more effectively against businesses in the same space. It may also offer opportunities for PE to increase prices on the back end when you decide to exit. Following an acquisition, the new consideration is whether to equip the portfolio company with extensive digital capabilities. These capabilities can offer many ways to create value within a portfolio company by improving its processes, as well as upgrading and expanding the product and service lines. To judge a company’s position and prospects, an investor has to know where the company and its competitors stand in the digitization revolution.
Businesses often settle on aspirations that are based on last year’s performance plus 5 or 10%. But the pandemic has shown that businesses can take huge leaps when pressed. As a rule of thumb, digital initiatives should change more than 20% of operating profits — even as revenue and profit-growth targets continue to rise. That means conversations at the board level, and between the board and management, must tackle the ways digital will change the technology model, operating model, or business model of the company — or even its industry. Company leadership must be pushed on Digital business models, value creation and capture.
Assessing digital capabilities
Investors that don’t make digitization part of the due diligence process are at greater risk than ever of missed opportunities and value traps. Assessing a company’s digital capabilities and developing them to their full potential may require firms to build out their own digital capabilities or align with strategic partners. Those that do will be better positioned to pick the right targets, avoid potential losses, maximize their portfolios’ value, and have greater success with preparing companies for the future.
During due diligence, wise PE firms are on the lookout for technical debt. Portfolio companies with technical debt may be running inefficient legacy systems that are costly to maintain, inflexible, and cause delays, often at just the wrong time. At the earliest opportunity in the investment the IT transformation project should be protected from losing money. It is essential to get under the hood, ensure that IT is set up for success and corrective action is implemented swiftly to protect the desired outcomes.
Where is the Risk? Time, Money & Leadership
Unfortunately, in general, 45% of tech-driven projects fail or don’t meet their objectives. In-flight projects often ‘market’ the huge benefits that they will deliver, but will they really do? Digitally transforming a portfolio company may be the right strategy if the firm is interested in a quick turnover. But revamping an acquisition’s IT infrastructure is something that typically takes significant time and money to get right, and it may extend your holding period. For many companies facing short-term pressures, this long-term focus can be particularly challenging (especially in capital markets) since digital transformations cost a lot while promising cash-flow and revenue payoffs that won’t arrive till much later.
Cost & Investment
Investment horizons at many companies tend to be too focused on the short term. Amazon, in contrast, has had a seven-year horizon for its investments. By developing a clear view of long-term value, the board can press the business to make the multiyear operating-expenditure and capital-expenditure spend that’s necessary to capture that value.
But when a multimillion Euro/dollar digital-transformation-investment plan is presented to the Board, can they evaluate it properly? Can they evaluate if it is too costly? Or if it is aiming too low? Or if it is focused on the right priorities? More than once Board members have confessed that they don’t know.
Preparing for a successful digitization project
It’s easy to measure costs when looking at bits of software and kit, evaluating lifetime value and being able to draw compelling accuracy with regards to ROI. To get past this stage, boards can start with a hard-nosed IT-Finance Value assessment that will give visibility about the cohesion of IT, Finance and the (Lines of) Business from a digital business point of view. It makes clear how to realize short term Quick Wins for the organization, while building long-term value for the business. One of the outcomes of such assessment will be a tailormade roadmap for the organization with clearly defined steps regarding which financial savings can be realized over time. By realizing 3% – 5% savings annually on IT run costs, yearly more funds will become available cumulatively (when top line budget remains the same) for funding the digitization of the business and business growth models. (Especially true when there is a longer horizon for IT investments). This assessment will help IT, Finance and General management of the company how to plan for and manage the digitization process better. It will give a clear view of:
- Which process improvements will result in less time spent.
- How more transparency can be realized in IT finances, so the business can understand it and help steer consumption, reduce costs and shift funds to projects that support the digital business initiatives.
- How data quality can be improved so that reporting & dashboards become more reliable.
- How better insights and control options can be provided.
To put it simply: For successful roll-out of digitization plans, one needs maximum grip on the costs, quality and performance of the IT organization. The question is ‘how do you realize that?’ Incomprehensible processes and insufficient alignment with the business often make IT a black box. With the help of Technology Business Management (TBM) this can be changed. TBM is a value management framework that will position IT as a valuable strategic partner within your organization and will put IT in the lead of the digitization process.
TBM is a value management framework used by chief information officers (CIOs), chief technology officers (CTOs), chief financial officers (CFOs) and their teams for data-driven decision making about IT initiatives. TBM defines the tools, processes, data, and people needed to manage the business of technology and has been adopted by enterprises across nearly every industry. These organizations are using the TBM framework to manage, plan, and optimize costs, value, and quality of all technology investments. TBM provides IT and Finance leaders with granular transparency on technology costs, so they can make investment decisions within the context of broader business goals. This will improve the alignment between IT, finance and the business and consequentially the creation of value for the organization.
By implementing TBM also the most difficult cost driver to quantify (and perhaps justify) for a successful digitization project, the investment in skills and leadership, will become easy.
Companies that have bitten the bullet
Too many board conversations default to how technology can improve efficiency and cut costs. Efficiency can indeed generate meaningful savings that can help meet the ongoing investment needs of a digital transformation. Below please find a brief description of two companies that have gone through this process successfully.
Aart Rupert (CIO, Damen Shipyards Group): “To be honest it was my initiative (as the CIO) and I discussed it with the other Board members and we made it (Cost Optimization) a Group wide program. The reason behind that was that I saw in our complex landscape we have more than 600 applications, that our real costs were becoming higher and higher. And there was no room anymore for new digital investments. So, we had to do something. And that was the reason we said: Let’s introduce the Cost Optimization Program”.
In order to fund this transformation Damen introduced 2 years ago a Cost Optimization program, defined by 4 layers:
- Level 1: IT Procurement Savings: This first layer is about saving money with the IT procurement contracts: Realize price reductions, better contracts, reduce waste and license optimization. We all know companies the size and complexity of Damen have a lot of contracts with suppliers who often also are partners. This level is about how to create savings here.
- Level 2: IT Cost Savings: This level is about cost savings within IT: data consolidation, application rationalization, infrastructure and IT process.
- Level 3: Joint IT and Business Savings: This layer is about on-, offboarding processes, reducing organization complexity, change for improvements, business process optimization, prioritization, reduction of IT services / IT service catalogue, licenses utilization, project rationalization and also application rationalization.
- Level 4: Business Restructuring & Innovation: This layer is about implementing new (digital) business models, executing & measuring, and gives the real savings in the business process optimizations. It is more complex than the previous levels, but the value is also higher.
- This Cost Optimization program makes it possible to free-up funds and to invest in the digital strategy. That is the objective.
Pieter Paul Weijer (Manager IT Cost Optimization Program, Damen Shipyards Group): “In 2019 we took the decision to start with Apptio and to adopt Technology Business Management (TBM) to help us achieve transparency of our IT and Technology costs. With the standardized approach of TBM we were able to translate a lot of data, partly structured and partly unstructured, towards the standard overviews, structures and taxonomy provided by TBM.
Then we found out that It’s Value as an Apptio partner was also based in the Netherlands and we approached them with the question if we could have an Agile way of implementation? Also we ascertained if It’s Value had the IT-Financial knowledge required for the project, an understanding of our specific needs, the knowledge and experience to design custom solutions, and experience with implementations in large and complex organizations such as Damen. They did.
By working with It’s Value we made a lot of progress in 2020, and finally achieved a successful implementation of Apptio Cost Transparency and IT Planning.”
To summarize, Damen achieved the following as a result of partnering with It’s Value in the first 18 months.
- Clear view on cost drivers / substantial expansion of service details
To give business units and IT management more control over and insight into their IT costs, a more detailed service catalogue and underlying cost allocation model was needed.
In an iterative process a new service and cost allocation model was developed. The already existing service catalogue was refined from 10 to over 50 services and allocation strategies were improved
The Apptio Cost Transparency module supports the data (transformation) functionality and modelling functionality needed for this, as well as the reporting tools to visualise the outcomes.
The implementation has resulted in:
- Traceable cost allocation to over 50 services
- Clear insights into cost drivers per service
- Insights into the interdependency between services sharing the same resources/semi-finished products.
- Automation of management reporting
Management reporting was previously done by Excel, combining multiple data sources for the management dashboard. The process was very labour intensive and questions on financial figures required separate analysis.
Data from relevant sources (general ledger, budget, HR and vendor systems) is now loaded into Apptio Cost Transparency. The Apptio out-of-the-box KPI’s and reports, with some custom reports added, fulfil Damen’s reporting demand to give them the insights they requested.
The management reporting dashboard has many advantages:
- 1 version of the truth: The reports can be used cross functionally (finance/it-management/ purchasing) all based on the same data.
- Quick: Reports are available within 1 day after month-end closing.
- Flexible: The same reports are used to analyse data from multiple dimensions (department, vendor, cost saving initiatives, etc.).
- Transparent: Drill down to actual source data is now possible.
- Analytics: the automation frees resources to give business control more time to analyse and advise management.
- Automation of budget and forecasting process
The goal was a less labour intensive planning process (both budget and forecasting), delivering more insights into planned labour and vendor spend.
Implementing the planning processes in Apptio IT Planning gave possibility to allocate budget lines directly to IT services or semi-finished products.
The result has a number of advantages:
- Multiple planning dimensions: next to department/account group also on the dimensions vendors, contracts and labour roles
- Comparison: plans (and actuals) can be easily compared to other plan(version)s in the standard available reports
- Monthly rolling Forecast: because of the time saving process automation, forecasts are made on a monthly basis
conversations with the business around things like project management, vendor management, and green-lighting (or not) new business requests for technology. Without the financial insights and cost transparency data Apptio provides, these conversations, as difficult as they are to have today, would have been nearly impossible in the past.
In the 12 months since they introduced the TBM model and Apptio, the Ferguson IT team has identified $12M in savings from the 2019 IT budget to help fund business transformation, which represents a 10 percent reduction in costs. With TBM and Apptio pointing the way with solid data and analytics around costs and allocations, this shift in run, grow, and transform mix is possible.
To help fund their new digital strategy, Ferguson’s TBM team is using Apptio to drive conversations with the business around things like project management, vendor management, and green-lighting (or not) new business requests for technology. Without the financial insights and cost transparency data Apptio provides, these conversations, as difficult as they are to have today, would have been nearly impossible in the past.
In the 12 months since they introduced the TBM model and Apptio, the Ferguson IT team has identified $12M in savings from the 2019 IT budget to help fund business transformation, which represents a 10 percent reduction in costs.
With TBM and Apptio pointing the way with solid data and analytics around costs and allocations, this shift in run, grow, and transform mix is possible.
“TBM is where the rubber meets the road,” said Carla Short, Senior TBM Manager at Ferguson. “By using Apptio, we’re able to look at how we’ve been performing on transform, we’re able to look at our applications and see where the burden is, we’re able to see what may need to be retired and things like that. We know where our TCO is.”
One of the most important benefits TBM is bringing to Ferguson is the ability to change the conversation from cost to value. Because of cost transparency, line of business leaders can finally see what their all-in costs are for a given technology, application, or service. This visibility into all the costs of providing a service or application—infrastructure, support, networking, compute, device, storage, licensing costs, etc.—lets them, often for the first time, answer the question, “Why does IT costs so much?” This dynamic is alive and well at Ferguson.
“With TBM and Apptio, instead of an accountant sending monthly spreadsheets with the actuals, the budget and the variance data, now everyone can go in into Apptio any day of the month and pull the data, and they can pull the historical data,” said Natalia Guley, a finance manager in Ferguson’s TBM office.
“There’s no more spreadsheets. We have great tables and charts, and there’s a drill-through functionality where you can view journal line details. Now, everything’s on one screen and it’s easy to navigate. It was all about transparency, so we gave access to everyone, so everyone can build around data. And that definitely started some conversations around the numbers, which was good.”
“TBM has changed the conversation around financials into actuals,” said David Rippon, Head of Group IT Finance at Ferguson, “and enabled us to make data-driven decisions. The financial transparency has been a big win for us.”
Wanting to limit risk and decrease IT run costs to fund the digitization strategy?
An IT-Finance Value Assessment is a good starting point and gives you visibility about the cohesion of IT and finance from a business point of view. It makes clear how to realize the short term Quick Wins for the organization, while building long-term value for the business. One of the outcomes is a tailormade IT-Finance (TBM) roadmap for your organization with clearly defined steps regarding:
- Which process improvements result in less time spent.
- How more transparency can be realized in IT finances.
- How your data quality can be improved so that reporting & dashboards become more reliable.
- Which opportunities can be realized to grow the business.
Also the IT-Finance roadmap will include a clearly defined plan regarding which financial savings can be realized over time. By realizing 3% – 5% savings annually the digitization process can become Self-funded.
Either during due diligence or after acquisition, but before starting the digitization process, wise PE firms make the necessary assessments. At the earliest opportunity in the investment the IT transformation project should be protected from losing money. Boards have a key role to play in guiding their organizations through successful, long-term digital transformations and maximizing value for the shareholders. Board members must be informed properly and request the necessary analysis to be done. Starting the digitization journey without an IT-Finance (TBM) roadmap is like sailing the ocean without a compass and a clear destination ahead.
- AlixPartners – Blog: Seven steps for private equity portfolio company digital transformation success, 5 July 2021, https://blog.alixpartners.com/post/102h26z/seven-steps-for-private-equity-portfolio-company-digital-transformation-success
- KPMG: The Digital Transformation Imperative; Why Private Equity firms must digitally transform to compete). https://assets.kpmg/content/dam/kpmg/us/pdf/2018/05/737580-nss-pe-digital-transformation-whitepaper-v18.pdf
- McKinsey article: 5 Questions Boards Should Be Asking About Digital Transformation, June 21 2021
- It’s Value – Blog: The Digital Transformation Process of a Traditional Shipbuilder: The Story of Damen Shipyards
- Apptio – Blog: Cost Transparency Fuels Digital Transformation at Ferguson. https://www.apptio.com/blog/ferguson-using-cost-transparency-fuel-its-digital-transformation/
It’s Value is the TBM expert in Europe. It’s Value has implemented ITFM and TBM processes and improvement projects at multiple companies and industries in Europe since 2009. It’s Value is a long-term Apptio partner and member of the TBM Council (tbmcouncil.org)
For more information about Technology Business Management, please visit the website of It’s Value – www.itsvalue.com
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