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Role of Lean Thinking in Private Equity

Private equity and lean don’t often go together. Private equity has been blamed for a lot of evils and problems, as this Boston.com cartoon lampoons:

But when they do, there are some great synergies. We have worked with many private equity firms, and private equity-held companies. The biggest synergy is that despite the pursuit of an exit, many private equity firms are longer-term thinkers than publicly-held companies. They don’t exactly hold a 30 year vision, but they aren’t focused on a quarterly number either.

Pete Abilla of Shmula blog wrote about it last week in the Role of Lean Thinking in Private Equity. In it he writes about the 3 primary roles:

 

1. Lean and Pre Acquisition Due Diligence
2. Lean and Post Acquisition Short Term Improvements
3. Lean and Enterprise Broad Organizational Improvements

He suggests that there are three primary questions to be answered in the due diligence phase from a lean thinking investor.

1. What are the opportunities for improvement in the company?
2. What degree of waste is present in the company?
3. If acquired, how much waste could be eliminated and by when?

Having done this many times, these are often the primary areas of focus from a lean thinking investor. Danaher, a famously lean-thinking company that has done many acquisitions as an industrial conglomerate, has stated that they are sometimes willing and able to outbid competitor investors because they see financial opportunities that the others do not see. With their lean lens on during the due diligence phase, they understand how to capture some hidden dollars and roll that into the value of the entity. Some private equity firms even employ their own lean resources to help go after some of the waste, although often those resources are limited to the lens of waste.

But lean is not just about waste elimination. I’ve written about that before, as has Kevin Meyer on Evolving Excellence in Lean is not just about waste. It is also about, or primarily about, adding value. A lean lens will help the investor understand how well the company is delivering on its promise of value, and what opportunities exist to improve that. This can in term lead to improved market share or improved margin, which often can have much larger financial impact that just waste elimination. For example, we were looking at acquiring a company and the prevailing attitude was that quality did not matter much. Literally, the thought was “why should our customers buy one product when they could buy two” implying they would need two to make sure one was always working. Once making the acquisition, this was fixed. Parts sales dropped like a rock, but overall sales increased 400 percent in 3 years. Due diligence should surface these opportunities.

But how do you become an organization? Through the skills, behaviors, and mindset of the people. Due diligence should also surface cultural problems, underutilized or non-existent skills, behavior gaps where they are shooting themselves in the foot, and so on. So much inspection is put into understanding the state and quantity of assets, including technology, software, and inventory. But human capital and intellectual capital is often just as valuable.

Private equity must be able to appreciate that HOW a company operates has a big impact on how well they perform. It’s not enough just to replace the CEO (we saw one private equity firm rotate in 4 CEOs in 5 years). If they appreciate this, then lean can be a great partner for them in building a more valuable, sustainable, and profitable company. And as Pete suggests in his post, that lens must start before the acquisition.