The competition for private equity (PE) deals is intensifying, and many PE portfolio companies in the telecommunications, media, and technology (TMT) industry are implementing cost reduction measures to stay competitive. Private equity firms, which are increasingly investing in software and other technology companies, need to find novel ways to create value beyond traditional operational and financial improvements. Product engineering provides a meaningful opportunity area for both portfolio companies and PE firms to drive margin improvement.

Why product engineering for value creation?

Private equity firms have excelled at creating value for portfolio companies through operational improvement, financial engineering, and bolt-on acquisitions. However, organic product development is often neglected among the many available value creation levers due to its perceived complexities and longer time value horizon. As decreased valuations entice new buyers into the market and competition intensifies, there are several reasons why PE firms should reconsider their value creation levers:

• No low-hanging fruit: PE firms have historically leaned on cost cutting and multiple expansions to create value in their portfolio companies. The threat of slow growth and a potential recession poses a risk in multiple expansions. Moreover, standard cost-cutting methods are often already implemented by previous management. As such, there is no more low-hanging fruit for portfolio companies, and PE firms need to explore new cost levers.
• Shift from cost cutting to profitable growth: Investors are increasingly looking for growth, and product development and expansion are essential to driving top-line growth. However, many companies, especially smaller ones, don’t have a formal process to manage portfolios and new product development efforts. In some cases, pipelines are clogged with low-value projects. Furthermore, undeveloped engineering processes and systems, especially in the software engineering space, often increase development cost and delay time to market. By focusing on software engineering, firms can prioritize resources to build the right products (e.g., profitable, high-value ones) cost efficiently and with faster time to market. Both aspects can help boost product innovation at scale and accelerate growth.
• Synergy across the portfolio: PE firms can establish engineering Centers of Excellence (CoE) to share best practices across portfolio companies and drive engineering efficiency. Leveraging best practices via a CoE is even more impactful in the software engineering space: A CoE can aid PE firms in deal negotiations, as it can create synergies that corporate buyers often bring to the seller.

Levers of opportunity: Growing revenue and reducing costs with product engineering

Five areas comprise product engineering: product strategy, portfolio management, product development, engineering tools, and engineering talent. Within each exists significant opportunity levers for value creation. Here are some of the critical opportunity levers where companies may focus their efforts:

Make product engineering a part of the deal

Making product engineering an integral part of a deal’s due diligence and post-close phases can create tremendous value for PE firms and portfolio companies. Organizations can level up by tapping product engineering early in the deal cycle and focusing on the following key activities (figure 1):

In addition to these activities, PE firms can leverage the CoE to drive best practices across portfolio companies. During the due diligence phase, PE firms can identify the target company’s gaps relative to best practices and, during post-close phases, implement best practices and utilize standard KPIs to track performance.

Using product engineering as a value creation strategy requires private equity firms to work closely with portfolio companies’ business and engineering leaders during the deal life cycle. The focus should be on increasing engineering efficiency to achieve both business growth and cost reduction. Since the product is at the core of many portfolio companies, these activities must be carefully executed to avoid product development disruption and customer confusion. Working with an experienced partner—one with industry, M&A, and software product engineering experience—to help navigate the product engineering improvement journey can be a significant value-add and vastly increase the potential to capture desired value.