What Private Equity Should Learn from Conglomerates

I was reading a Fortune article talking about why private equity is in deep freeze given the recession. I tend to think it has more to do with how most of these firms are used to operating than the economy itself. For the first time in a long time, they need to manage the firms that they got with a longer-term perspective on the fundamentals of the business in terms of sustainable profitable growth as opposed to high-leverage / quick-exit / high-multiple approach. They also need to learn to work with the existing management teams with more emphasis on human capital development. I now several great executives who quit their firms following the acquisition by a private equity firm. PE firms must also focus on creating more synergies (e.g. procurement, centralized cross-selling/CRM etc.) among their portfolio companies.

Buyout firms with huge stockpiles of cash aren't making new deals. The reason? They're too focused on trying to manage the companies they've already got.

NEW YORK (Fortune) -- If the credit markets have been an iceberg over the past year, the private equity business has been frozen as solid as a prehistoric glacier. Buyout giants like KKR, Blackstone, and Bain Capital -- who just a couple of years ago were vying to one-up each other on a monthly basis with new mega-deals -- have been in a virtual hibernation for months.

In the first half of 2009, just $24 billion in deals were completed globally. That compares to $131 billion last year and an astounding $528 billion in deal volume in 2007. This year's first-half total is the lowest since 1996, when the buyout industry was much smaller. There were only three loans extended to fund leveraged buyouts through June, the fewest number since 1985 according to Dealogic.

In recent weeks, though, the stock market has begun to rally and the cost of borrowing has begun to fall. So it's natural to wonder: Is the buyout market about to heat up again?

Don't be on it, say industry insiders. Private equity is still in the early stages of a long thaw.

Digesting last cycle's deals

The problem is not that firms don't have money to spend. In fact, according to private equity research firm PitchBook, the industry is sitting on an estimated $400 billion worth of so-called dry powder, or money raised but not yet invested.

No, the reason that dealmaking isn't going to come roaring back is that private-equity firms are simply still too busy trying to digest the companies they swallowed during the boom years.

"The business has changed radically," says John Howard, head of Irving Place Capital, the former Bear Stearns Merchant Banking unit, which he helped rescue from the wreckage of Bear. "What was essentially a business of creating financial options is becoming more concerned with growth and enhancing profitability."

A survey earlier this year by the Association for Corporate Growth, a buyout industry group for consultants, found that 89% of private-equity executives said they were planning on spending a lot more time than before focusing on their portfolio companies.

Of course, private equity investors have always claimed that their business was all about "improving" the companies they buy through streamlining operations. (At least enough to service the huge debt loads they pile on in the acquisition.)

But in reality, the velocity of the business -- fueled by cheap debt to buy companies and hungry equity markets to resell them to -- typically discouraged much more than blunt-force cost-cutting. Only the very biggest firms have ever paid much attention to teaching management skills or thinking about ways to share costs among portfolio companies.

"We saw people talk a lot about building platforms," says Andrew Wilson, managing partner in divestiture services at Deloitte & Touche, referring to the industry's term for buying companies and working to combine them in creative ways. "But we didn't see so many execute them."

Despite the stock market's rally, firms don't expect much demand for their holdings any time soon. Part of the reason is that newly skeptical investors wouldn't think about investing in the debt-laden companies they own. According to Standard and Poor's, an astonishing half of all defaulting companies this year as of June were owned by private-equity firms.

"The environment has changed, and the holding period is expected to be a lot longer," says Blackstone's senior managing director in charge of portfolio management, James Quella. "The ability to use financial engineering for enhancing returns has been curtailed and limited on existing portfolios."

A survey by Coller Capital, which invests in stakes in private equity deals, found that two-thirds of people in the industry believe the environment will stay the same or even get worse next year.

Learning to manage

So in an attempt to generate some kind of returns for their investors in that time, firms are turning more aggressively to the time-honored tradition of creating value through cost savings. Such savings are being achieved by running their portfolio companies more like divisions of a parent, cutting costs across businesses and getting all the top managements in a room together more often.

It's an ironic turn of events, given that the earliest private equity deals were a response to the conglomerate booms of the 1960s and '70s, when bloated, unmanageable behemoths like Gulf + Western and ITT were built.

Gary Stibel, founder and CEO of the New England Consulting Group, has been working with private-equity firms since those days. "Traditionally, firms delegated that kind of management stuff to advisory partners, or just didn't really pay much attention," he says. "Now they're focusing on it and doing it more themselves."

One increasingly popular practice is called "leveraged sourcing," in which the many companies owned by a firm will pool their buying orders from suppliers -- ranging from telecom services to temp workers -- to get bigger bulk discounts.

"We're getting a ton of phone calls on this," says Richard Jenkins, a managing director at turnaround advisory firm Alvarez & Marsal, which recently launched a group dedicated to private-equity consulting. "Each week, we get another two or three calls asking us about what they can do to cut costs and manage more centrally."

Even mega firms that have done this in some form in the past are expanding. Blackstone has long had a group, called CoreTrust, that purchases across its businesses. It is the single largest U.S. customer to Staples for example.

Quella recently led Blackstone into a new area for leveraged sourcing: health care. Since January, Blackstone has asked companies to participate in a group plan that is now Aetna's fifth-largest and Anthem's ninth-largest customer. The health group also runs prevention and wellness programs across its companies.

Still about selling

There are limits to the process, however. Not all business functions can be merged. Howard of Irving Place Capital says that advertising in particular is a touchy area.

"I've learned from the experience of buying an ad agency to use for all the businesses," he says, "For the head of marketing, choosing an agency is one of their most important decisions. It was emasculating to them."

Will cost savings single-handedly save private equity's returns? Consider that Blackstone's two most recent funds raised nearly $30 billion. A 10% reduction in health-care costs of $2 billion would save $200 million, or create about $1.4 billion in value, assuming they can sell the companies for seven times their earnings. Using some rough, unscientific math, that's about a 5% return on those funds.

So while private-equity firms may make a virtue of their focus on growth, it is still the selling of those assets -- not the managing of them -- that defines them.

"Private equity will always be the business of selling companies," says Stibel. "Exit timing and strategy is significantly more important for overall returns. More important than even the companies." Meanwhile, they have to manage the best they can.

Good to Great to Gone!

Jim Collins, a management guru, ponders business failure

ONE of the keys to being an inspirational management speaker is not to dwell too long on the negative. No wonder Jim Collins is almost apologetic in his new book on corporate failure, “How the Mighty Fall”. As he writes, “When I sent a first draft of this piece to critical readers, many commented that they found our turn to the dark side grim, even a bit depressing.” Happily, he reaches an upbeat, empowering conclusion: “Whether you prevail or fail, endure or die, depends more on what you do to yourself than on what the world does to you.” He expands on this theme by quoting Winston Churchill’s injunction to “Never give in, never give in, never, never, never, never...”

The risk for a management guru with a sunny outlook is that writing books praising companies creates hostages to fortune. One well-known title, “In Search of Excellence”, left its authors wiping egg from their faces when many of the firms they profiled quickly proved to be anything but excellent. Even worse was Gary Hamel’s celebration of Enron, “Leading the Revolution”, which was still arriving in bookstores when the energy-trading company blew up in 2002.

So Mr Collins has wisely grasped this nettle before any of his critics could sting him with it. As he readily admits, several of the firms praised in his bestsellers, “Built to Last” and “Good to Great”, have since fallen from grace. These include Circuit City, a now-bankrupt electronics retailer, and Fannie Mae, a giant mortgage lender that was taken over by the American government last September to stop it going bust and taking the global financial system with it. Oops.

In his new book Mr Collins examines 11 of the 60 “great companies” studied in his two earlier books that have since deteriorated to “mediocrity or worse”. Mr Collins says that when he charted the factors that led these firms to greatness, he had never claimed that they were certain to remain great. By comparing each one, where possible, with similar firms that had fared better, Mr Collins identifies five stages in the process of decline. Stage one is hubris born of success (possibly brought on by reading the case study of the firm in one of Mr Collins’s earlier books). Firms start to attribute their success to their own superior qualities. They become dogmatic about their specific practices and fail to question their relevance when conditions change.

Stage two is the undisciplined pursuit of more: firms overreach, moving into industries or growing to a scale where the factors behind their original success no longer apply. Stage three is denial of risk and peril. Warning signs mount, but the firm’s headline performance remains strong enough for bosses to convince themselves that all remains fine. Problems are invariably blamed on external causes.

In stage four the problems are clear enough that firms start grasping for salvation. Rather than returning to the fundamentals that made them great (which Mr Collins regards as the most promising route back to greatness), they gamble on a new, charismatic saviour-boss, dramatically change strategy, make a supposedly transformational acquisition or fire some other supposedly silver bullet. The longer a company remains in stage four, the more likely it will spiral downward into stage five: irrelevance or death. However, inspired (at times, perhaps too much) by the Churchillian belief in never giving up, Mr Collins points out that many still-great firms have bounced back even after getting to stage four, including IBM, Nucor and Nordstrom.

At the very least, “How the Mighty Fall” is worth buying as a gift for the hubristic boss in your life, to remind him of the need for humility. Show the recipient the striking chart comparing Wal-Mart and Ames, two retailers with identical strategies, the share prices of which grew in tandem for decades before diverging forever in the mid-1980s. A disastrous acquisition by Ames in 1988, designed to double the size of the firm overnight, was a classic case of overreach. In two years it was bankrupt; in 2002 it was liquidated. Wal-Mart, meanwhile, stuck to its original strategy, and despite a few wobbles, became the world’s largest and most profitable retailer.

The book was finished just as the financial markets crashed last year, so Mr Collins does not explore the implications of this shock as deeply as he might. However, he points out that financial firms can move through the five stages of decline—and particularly the final three stages—much faster than other sorts of company. And companies already in decline, as Fannie Mae was by last year, are extremely vulnerable to turbulence. Without the financial storm of last year, he speculates, “perhaps Fannie Mae would have had an opportunity to reverse its own decline and return to greatness by its own efforts.”

Moreover, what happened to the world’s once-mighty financial firms last year illustrates that the five stages of decline can apply to an entire industry as well as individual firms. Even so, says Mr Collins, companies need not be imprisoned by their industries. “Not every financial company toppled during the 2008 crisis, and some seized the opportunity to take advantage of weaker competitors in the midst of the tumult.”

He has a point. Before the crisis most people regarded JPMorgan as the strongest universal bank and Goldman Sachs the strongest investment bank. Though both came close to disaster during the crisis, both look even more dominant now that things are getting back to normal. Perhaps last summer they got an early look at Mr Collins’s book and followed his advice: “Our research shows that if you’ve been practising the principles of greatness all the way along, you should get down on your knees and pray for severe turbulence, for that’s when you can pull even further ahead of those who lack your relentless intensity.” Amen.

from economist.com

6 Questions to Ask Before Starting a Business

1. Do you believe you have what it takes?

2. Are you able to let other people down?

3. How do you handle setbacks?

4. Are you really an inventor, rather than an entrepreneur?

5. Can you accept that your company may outgrow you?

6. When you look in the mirror, does an entrepreneur look back?

We don't mean personal characteristics -- or not just personal characteristics, anyway. Do you believe you have all the skills, energy, money, people, and knowledge to start a business? Founders who carefully identify and evaluate their resources in pursuit of a well-defined goal display "entrepreneurial self-efficacy," a trait many academics believe to be the best predictor of success.

2. Are you able to let other people down?

3. How do you handle setbacks?

4. Are you really an inventor, rather than an entrepreneur?

5. Can you accept that your company may outgrow you?

6. When you look in the mirror, does an entrepreneur look back?

We don't mean personal characteristics -- or not just personal characteristics, anyway. Do you believe you have all the skills, energy, money, people, and knowledge to start a business? Founders who carefully identify and evaluate their resources in pursuit of a well-defined goal display "entrepreneurial self-efficacy," a trait many academics believe to be the best predictor of success.

A founder may set out in a rowboat, but pretty soon, he is piloting a cabin cruiser with investors and employees on board and their families huddled belowdecks. Risking your own fortunes is easy compared with risking the fortunes of those who believe in you. "These people may not completely understand the business," says J. Robert Baum, an associate professor of entrepreneurship at the University of Maryland. "They may not understand the level of risk. But they think they'll be OK because you are so smart. Breaking their dreams is very painful."

3. How do you handle setbacks?

4. Are you really an inventor, rather than an entrepreneur?

5. Can you accept that your company may outgrow you?

6. When you look in the mirror, does an entrepreneur look back?

We don't mean personal characteristics -- or not just personal characteristics, anyway. Do you believe you have all the skills, energy, money, people, and knowledge to start a business? Founders who carefully identify and evaluate their resources in pursuit of a well-defined goal display "entrepreneurial self-efficacy," a trait many academics believe to be the best predictor of success.

A founder may set out in a rowboat, but pretty soon, he is piloting a cabin cruiser with investors and employees on board and their families huddled belowdecks. Risking your own fortunes is easy compared with risking the fortunes of those who believe in you. "These people may not completely understand the business," says J. Robert Baum, an associate professor of entrepreneurship at the University of Maryland. "They may not understand the level of risk. But they think they'll be OK because you are so smart. Breaking their dreams is very painful."

When you are smiling, the whole company smiles with you. In their book Resonant Leadership: Renewing Yourself and Connecting With Others Through Mindfulness, Hope, and Compassion, Richard Boyatzis and Annie McKee explain that emotions are contagious: Morale rises and falls with the mood of the leader. Consequently, people who succumb to black moods or depression can fatally infect their own companies.
Because some people have an inflated idea of their resilience, Mayer suggests performing a kind of reference check on yourself -- ask people who know you well how you handle adversity.

4. Are you really an inventor, rather than an entrepreneur?

5. Can you accept that your company may outgrow you?

6. When you look in the mirror, does an entrepreneur look back?

We don't mean personal characteristics -- or not just personal characteristics, anyway. Do you believe you have all the skills, energy, money, people, and knowledge to start a business? Founders who carefully identify and evaluate their resources in pursuit of a well-defined goal display "entrepreneurial self-efficacy," a trait many academics believe to be the best predictor of success.

A founder may set out in a rowboat, but pretty soon, he is piloting a cabin cruiser with investors and employees on board and their families huddled belowdecks. Risking your own fortunes is easy compared with risking the fortunes of those who believe in you. "These people may not completely understand the business," says J. Robert Baum, an associate professor of entrepreneurship at the University of Maryland. "They may not understand the level of risk. But they think they'll be OK because you are so smart. Breaking their dreams is very painful."

When you are smiling, the whole company smiles with you. In their book Resonant Leadership: Renewing Yourself and Connecting With Others Through Mindfulness, Hope, and Compassion, Richard Boyatzis and Annie McKee explain that emotions are contagious: Morale rises and falls with the mood of the leader. Consequently, people who succumb to black moods or depression can fatally infect their own companies.
Because some people have an inflated idea of their resilience, Mayer suggests performing a kind of reference check on yourself -- ask people who know you well how you handle adversity.

Raising a child is generally more challenging than creating a child, and the same is true of new products. Some people mistake the act of invention for the tough part. "Too many times, these inventor types spend an inordinate amount of time on the patent and making the prototype just so," says Mike Drummond, editor in chief and co-owner of Inventors Digest. "They think once they've done that, the world will beat a path to their doorstep. My take is that product development is a team sport. Inventors don't get that. Entrepreneurs do."

5. Can you accept that your company may outgrow you?

6. When you look in the mirror, does an entrepreneur look back?

We don't mean personal characteristics -- or not just personal characteristics, anyway. Do you believe you have all the skills, energy, money, people, and knowledge to start a business? Founders who carefully identify and evaluate their resources in pursuit of a well-defined goal display "entrepreneurial self-efficacy," a trait many academics believe to be the best predictor of success.

A founder may set out in a rowboat, but pretty soon, he is piloting a cabin cruiser with investors and employees on board and their families huddled belowdecks. Risking your own fortunes is easy compared with risking the fortunes of those who believe in you. "These people may not completely understand the business," says J. Robert Baum, an associate professor of entrepreneurship at the University of Maryland. "They may not understand the level of risk. But they think they'll be OK because you are so smart. Breaking their dreams is very painful."

When you are smiling, the whole company smiles with you. In their book Resonant Leadership: Renewing Yourself and Connecting With Others Through Mindfulness, Hope, and Compassion, Richard Boyatzis and Annie McKee explain that emotions are contagious: Morale rises and falls with the mood of the leader. Consequently, people who succumb to black moods or depression can fatally infect their own companies.
Because some people have an inflated idea of their resilience, Mayer suggests performing a kind of reference check on yourself -- ask people who know you well how you handle adversity.

Raising a child is generally more challenging than creating a child, and the same is true of new products. Some people mistake the act of invention for the tough part. "Too many times, these inventor types spend an inordinate amount of time on the patent and making the prototype just so," says Mike Drummond, editor in chief and co-owner of Inventors Digest. "They think once they've done that, the world will beat a path to their doorstep. My take is that product development is a team sport. Inventors don't get that. Entrepreneurs do."

Some entrepreneurs love to brag that they don't need an exit strategy, because they are not going anywhere. But at some point, your business may need you less than you need it. That's particularly true at fast-growth companies, at which entrepreneurs may not have enough time to develop the necessary leadership and business skills. Mayer has seen founders bring in presidents or senior executives from the outside, only to sabotage them. "They do it by not giving them the necessary information," says Mayer. "They do it by not stepping back and by involving themselves with managers in a way that is inappropriate in the chain of command. They can be disruptive during meetings."

If so, and if that's the reason you are starting a company, beware. Many traits -- persistence, creativity, and risk tolerance among them -- are commonly ascribed to entrepreneurs. But having those traits doesn't much improve the odds that you will succeed. "Research into entrepreneurs' personal traits says things like persistence and need for achievement explain only about 5 percent to 10 percent" of the difference between people who start companies and those who don't, according to Baum. "They are less important than external predictors like the spirit of the times, the economy, and changes within an industry.

6. When you look in the mirror, does an entrepreneur look back?

We don't mean personal characteristics -- or not just personal characteristics, anyway. Do you believe you have all the skills, energy, money, people, and knowledge to start a business? Founders who carefully identify and evaluate their resources in pursuit of a well-defined goal display "entrepreneurial self-efficacy," a trait many academics believe to be the best predictor of success.

A founder may set out in a rowboat, but pretty soon, he is piloting a cabin cruiser with investors and employees on board and their families huddled belowdecks. Risking your own fortunes is easy compared with risking the fortunes of those who believe in you. "These people may not completely understand the business," says J. Robert Baum, an associate professor of entrepreneurship at the University of Maryland. "They may not understand the level of risk. But they think they'll be OK because you are so smart. Breaking their dreams is very painful."

When you are smiling, the whole company smiles with you. In their book Resonant Leadership: Renewing Yourself and Connecting With Others Through Mindfulness, Hope, and Compassion, Richard Boyatzis and Annie McKee explain that emotions are contagious: Morale rises and falls with the mood of the leader. Consequently, people who succumb to black moods or depression can fatally infect their own companies.
Because some people have an inflated idea of their resilience, Mayer suggests performing a kind of reference check on yourself -- ask people who know you well how you handle adversity.

Raising a child is generally more challenging than creating a child, and the same is true of new products. Some people mistake the act of invention for the tough part. "Too many times, these inventor types spend an inordinate amount of time on the patent and making the prototype just so," says Mike Drummond, editor in chief and co-owner of Inventors Digest. "They think once they've done that, the world will beat a path to their doorstep. My take is that product development is a team sport. Inventors don't get that. Entrepreneurs do."

Some entrepreneurs love to brag that they don't need an exit strategy, because they are not going anywhere. But at some point, your business may need you less than you need it. That's particularly true at fast-growth companies, at which entrepreneurs may not have enough time to develop the necessary leadership and business skills. Mayer has seen founders bring in presidents or senior executives from the outside, only to sabotage them. "They do it by not giving them the necessary information," says Mayer. "They do it by not stepping back and by involving themselves with managers in a way that is inappropriate in the chain of command. They can be disruptive during meetings."

If so, and if that's the reason you are starting a company, beware. Many traits -- persistence, creativity, and risk tolerance among them -- are commonly ascribed to entrepreneurs. But having those traits doesn't much improve the odds that you will succeed. "Research into entrepreneurs' personal traits says things like persistence and need for achievement explain only about 5 percent to 10 percent" of the difference between people who start companies and those who don't, according to Baum. "They are less important than external predictors like the spirit of the times, the economy, and changes within an industry.