How to Drive Greater Capital Efficiency

When evaluating potential investments, private equity firms and managers have plenty to discuss about capital efficiency. Is the company burning through its investment capital? What about the inventory turnover ratio? How can we improve capital efficiency post-acquisition?

These are the kinds of questions firms ask about the companies they invest in every day. However, it’s less often that they ask their internal teams to report on the ratio of outputs generated over capital expended.

Instead, the focus is usually on increasing profits—a natural goal to focus on, especially for firm leaders tasked with improving profitability. Just as you would for one of your investments, prioritizing the efficient use of capital is critical to your firm’s financial success.

For context, take a look at the chart below from PwC. Then read on to learn more about framing your own company’s capital efficiency.

3 steps to capital efficiency

According to Strategy&, the global strategy consulting firm of PwC, firms focus on two principal value creation levers — increase profits and improve capital efficiency. Private equity firms take a particularly sharp-penciled approach to release cash flow, but public companies can still learn a lot from their example. We have helped many corporate clients pursue a PE-like agenda to enable capital-efficient, profitable growth. The key is to start with a blank slate and then objectively and systematically rebuild the company’s cost structure, justifying every expense and resource. We call this a “parking lot” exercise — we advise clients to, in effect, remove every resource and expense from the building, place it in the parking lot, and then determine whether it deserves to be let back in. There are three basic steps in this process:

1) Review completed work and determine its purpose
The suggestion Strategy& has is for management teams to assess every activity your company performs and assign it to one of three categories:

  • “Must-have” work, which directly fulfills legal, regulatory, or fiduciary
    requirements, or is required to run the ongoing operations of the company.
  • “Smart-to-have” work, which directly provides differentiating service
    to customers, informs critical business decisions, or enhances
    employee performance, strengthening critical capabilities
    that allow the company to outperform its competitors.
  • “Nice-to-have” work, which describes all remaining expenses; in
    the pursuit of quick cash and sustained value creation, these activities
    should be viewed as discretionary and dialed down aggressively.

2) Eliminate low-value, discretionary work
Strategy& reports that “must-have” work accounts for as little as 15 percent of total expenditures, while “nice-to-have” work constitutes about 33 percent. Private equity and alternative asset firms have a tendency to reduce or eliminate “nice-to-have” and “smart-to-have” work, but it’s important to consider how each affects value creation before making that decision.

3) Optimize remaining high-value or mandatory work
Finally, streamlining the expenses related to “must-have” and “smart-to-have” work is a critical factor in realizing improved efficiencies. Explore automation, process improvement, consolidation, and even outsourcing to gain economies.

Atlas Venture, a biotech-focused early stage venture capital firm, thinks of capital efficiency as the “sweet spot” where the value is generated by per unit dollar invested. They’ve found that funding a company with extra capital will result in decreased returns while funding it too little will starve a business and also result in reduced profits. Put that way, why wouldn’t that fundamental principle be applied to your own private equity or venture capital firm?

Of course, investment prowess will continue to be the main attraction for potential investors. However, these days, you can expect those same investors to want to know how efficiently your firm is managing its funds and day-to-day operations. With a savvy capital efficiency plan in place, your firm can easily prove that you practice what you preach.

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A traditional crm was built for general ‘customer’ scenarios

Software platforms have made the world a better place by making work a better place. Indeed the world is better off when people enjoy their jobs even marginally more, and workplace applications on big CRM platforms like have done that and much more.

But the potential that platforms like these offer presents diminishing returns: once the platform provider has engineered too many industry specific components into its platform, its usefulness for other industries begins to be threatened, and with that so do the usefulness of the component tools built into the platform.

So it is with the CRM category that has defined: it is generic enough to work for many industries, and yet still offers the potential for others to round off the edges and nail more vertically-oriented and extremely tailored software solutions.

Private capital markets are actually a great demonstration of this dynamic. Where generic CRM platforms simplify — appropriately so — to assume there’s a business, a customer, a sale, and service of that customer, there are a few industry-specific pieces that are missing.

Take for example, that investors become customers by investing through legal entities the GP raises. It’s a subtle but important nuance that just doesn’t make sense at a platform-as-a-service level (because it’s overly complicated for a simple one-time sale that many industries require), but which can easily be added without 10 years or software engineering. Once provided, the rest of the platform’s components become tremendously powerful again and you’re set to take over the world.

As a traditional CRM in our pillars methodology, these nuances must be present to properly account for investors in these legal entities, potential target companies and which are owned by these entities, the context of all interactions with these parties (as well as the appropriate overlap, ie co-investments), and how you’re arriving at finding these opportunities on both sides of the equation, such that you’re able to piece together what’s effective and what’s not. Not just because we say so, but because these are the very relationships and data that are key to the motivation behind a CRM in any industry.

It’s critical, too, that the valuable publicly-available information that helps to enrich CRM systems and save users painful steps of entering it themselves is fully-integrated at the platform level.

Again, look no further than the 3,000+ pre-built integrations that — the creator of the CRM platform concept — has at a platform level to do so, and which only exists by way of holding just short of overly-specifying certain industry workflows that would present challenges to properly integrate.

Stakeholder reporting and communication (investor relations) draws on a range of datasets

The traditional “customer service” model of CRM systems once again makes overly-simplified assumptions about the customer relationship when applied to private capital markets.

In fifteen years I personally have yet to hear the terms “warranty” or “service call” in this market because it’s just not the same. But make no mistake, as uncomfortable as it may be to say aloud, customer service is more important now than ever and it’s constantly happening; the industry is, after all, considered to be a financial “service”.

As it turns out, that service is primarily information-based — it’s driven by data and takes the form of reports and analysis that drive decisions, and then end up again in investor-facing reports and analysis.

The foundational elements of a private capital markets CRM must be built such that they accommodate this data (like we discussed above), but so too that it can accommodate additional supporting data that investors (customers!) need in the context of service.

Oftentimes this supporting data — financial metrics and time-based values, for example — is believed not to meet the traditional definition of CRM and the natural thought is “well, better do this in Excel!”.

While I happen to believe Excel is still the greatest software application ever built, its introduction to this value chain we’ve discussed herein actually creates the problem many firms suffer from: key data needed to provide customer service (again: effectively the entirety of a firm’s reports and analysis) is now in disparate systems and detached.

Both of those dynamics are important and distinct: not only is this supplemental data disparate, but when brought together there is no logical association that can be made between the two data sets.

Allow me, then, to make the point very simply: not only can this financial and time-based value data (you may be thinking about is as “portfolio monitoring” or “accounting”) be a part of a CRM, it is arguably the most important part of a CRM because it’s at the core of what providing service to the customer entails — information that comes out of data!

Firms need a digital method to engage stakeholders (ie investor portals)

Investor portals are not new; in fact, for many of us — including myself — they conjure up horrifying nightmares in which we’re aimlessly guessing at folders to find the newest document we need.

So in lies the opportunity: not only have the portals we’ve come to hate not simplified the process of acquiring information, they’ve failed to create an entirely new experience that is “customer service” driven.

To be fair, this is not a B2C market where you’d be long out of business for not having focused on customer service and thus the customer’s technology-driven experience. But don’t expect to be around too much longer if you aren’t thinking about this shift.

Today’s institutional investors increasingly expect this same consumer-like experience, and a massive opportunity is being missed by not providing it. It’s not about providing them the experience they desire; it’s more about the ability to measure engagement that is had in return.

Put simply: what’s keeping the market from providing this experience is the availability of the information that’s required to create the service that provides the experience.

If you’ve hung in this long, you know that by focusing on your CRM, you have the data that’s required to manage the customer relationship and the technology-driven experience through which that information is shared to create a differentiated and opportunistic customer experience.

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