The combination of high interest rates and slowing sales growth is making cost optimization and EBITDA improvement primary discussion topics for PE firms and their portco’s board agenda. During periods of increased economic headwinds similar to 2008, pulling on high-value cost savings levers (people, technology, and COS/COG inputs) can be the competitive advantage for PE firms looking to protect and improve EBTIDA ahead of worsening economic conditions, per the World Economic Forum’s recent 2023 report. There are several key cost optimization levers around direct inputs/cost effectiveness (cost of sales and goods), people/talent, and performance improvement that PE firms should work with their portco management team to assess and execute against.
Key Cost of Goods and Sales Levers
The cost of goods and sales such as raw materials or compensation are usually the single biggest input cost for any business. Historically, PE firms have focused on below the line expenses. Based on May 2023 Federal Reserve reporting, inflation and salary increases have begun to ease from the 2021/2022 historic peak. This slowdown provides an opportunity for PE firms to reduce costs in the largest cost area for a portfolio company. MorganFranklin recommends evaluating and prioritizing opportunities with average savings of 5 to 10% of total costs:
- Assessing sales and GTM efficiency per FTE (e.g., what % of your workforce generate current sales and future pipeline on a per-person basis)
- Understanding current goods or products to assess key cost components and opportunities for input substitution or alternative supplier options
- Filtering current R&D projects’ ROI to eliminate ineffective projects and reengineering high-value projects to improve future margins
Key People/Talent Cost Levers
As a result of over hiring amidst the pandemic, PE companies need to assess their headcount productivity on an FTE basis and determine if the current talent meets future state needs (AI/ML, data analytics). Cost optimization begins with an internal assessment of the current workforce, how they fit future business needs, and existing people and talent productivity opportunities. These levers typically have a higher savings impact (10 to 15% of total costs), but also a higher complexity to implement due to ESG and train/upskill cost concerns:
- Conducting a skills assessment vs. planned business needs for next 12 to 24 months
- Understanding key gaps vs. business needs and identifying alternative lower-cost models to meet these gaps (e.g., virtual employees, nearshoring or offshoring data/analytics or product development talent)
- Exploring new operating model for key back-office functions like Finance and IT into a centralized, cost-effective structure including outsourced options such as MSP
- Leveraging automation/machine learning capabilities to eliminate lower value activities (e.g., customer service)
Performance Improvement/Operational Excellence
Performance improvement, including operational excellence is the lever by which a PE portfolio company assesses its operations relative to its peers. Bringing a “performance improvement” approach to the portfolio company is a preferred choice to quickly realize significant cost savings (5 to 15% of total costs) with minimal headcount impact. This approach includes the following key steps:
- Benchmarking all commercial and operational costs (e.g., IT, ERP, supply chain, SG&A, GTM, sales and marketing costs)
- Conducting a deep dive on the two to three operational red flags (e.g., manufacturing, P2P, inventory management)
- Assessing operational excellence capabilities and programs including potential automation opportunities
- Analyzing operations to identify redundant activities and evaluating policies and procedures to highlight potential pain points or bottlenecks to eliminate
PE firms should develop a well-structured and repeatable cost optimization playbook to execute across their portfolio companies with tailored approaches for each area (e.g., people/talent) given industry-specific considerations (e.g., Healthcare/HIPAA, tech/IT costs).
How MorganFranklin Can Help
If your organization is struggling with identifying and implementing cost optimization within your PE firm or portco and wants to improve EBITDA performance, then having a trusted partner with significant PE cost optimization experience is essential. MorganFranklin’s private equity professionals, which includes former COO, CFOs and CROs, work with companies to design and execute cost optimization opportunities that drive value to the portco and PE firm.
