January 24, 2022 – One constant about private equity is that the landscape is always changing. For some, those changes can lead to obsolescence; but for those with vision, change is an opportunity to unlock new opportunities for alpha returns, according to a new report from Upwork. “One relatively slow-moving change? The differentiating levers that a PE firm can pull as part of its value creation strategy,” said report author Tim Sanders, Upwork’s VP of customer insights. “It’s taken decades of evolution, but we’ve arrived at the doorstep of a newly emergent PE value creation driving force: talent transformation,” he said.
During the 1980s, Mr. Sanders said, private equity firms were masters of leverage, buoyed by reasonable buyout prices and ample credit. “As the years went by, financial engineering to improve arbitrage gained more share of value creation,” he said. “But at some point, in the ’90s, competition for buyouts raised their multiples and made it harder to drive alpha in a sustainable way.” According to a Boston Consulting Group study, operational improvements gradually became the biggest driver of a PE firm’s value creation success. Today, “buy and improve” is the key component of most value creation plans (VCPs), showing up in 84 percent of those studied by Harvard Business School.
How Did We Get Here?
There are many ways to drive operational improvement; one consultant identified 22 levers with varying degrees of complexity and risk. “Cost cutting, pricing and capital investments can all help drive efficiencies,” Mr. Sanders said. “But there are limits to how far they can go and it’s hardly a differentiated strategy.”
“What PE firms need now is a low-investment resource that can drive business transformation at portfolio companies in a short period of time, taking into account their limited resources to manage the process,” Mr. Sanders said. “Fifteen years ago, cloud computing came to market, led by Amazon Web Services and Microsoft Azure. Today, many portfolio companies have already integrated cloud economics into their technology stack or even started out cloud-first.”
So, what is the next big lever for value creation?
The On-Demand Talent Economy Makes an Entrance
About a decade ago, freelance marketplaces rose to prominence, mostly adopted by small businesses and start-ups to extend their punching power in competitive markets, according to Mr. Sanders. “They were able to bring on specialized talent without taking on the risk of traditional employment,” he said.
“As these marketplaces developed more robust digital and financial accounting features, mid-size and large companies began to tap into this ecosystem as part of their digital transformation initiatives. In the course of my work, I’ve interviewed PE portfolio company leaders, who revealed how they made on-demand talent ‘a part of their water supply’ and how it helped them execute VCP action items at a rapid cadence.” Unlike conventional ways to implement high-efficiency and breakthrough growth, this approach was embraced throughout these companies, lifting employee morale and retention, he noted.
This Path to Value Creation Is Different
“Don’t confuse this type of talent solution with analog solutions from the past like outsourcing or traditional staffing services,” Mr. Sanders said. “On-demand talent platforms offering access to freelancers and contractors are a digitally-driven innovation that give managers a sense of support and control over their workflows. Their talent management process is totally transparent, which creates internet-level economics when it comes to the net cost of resourcing the work.”
These platforms, he said, give managers direct access to talent so they can match those independent professionals with project- or role-based tasks. They can rely on ratings, reviews and virtual talent benches they build up to ensure quality, availability and a laser focus on managing deliverables.
Tim Sanders is vice president of customer insights at Upwork. In this role, he helps businesses implement better ways of working through the adoption of flexible talent solutions. Mr. Sanders has more than 25 years of experience, spanning from his time as chief solutions officer at Yahoo to an early-stage team member of Mark Cuban’s broadcast.com and at his own research-based consultancy. He is also a New York Times bestselling author.
Mr. Sanders also noted that risk can be mitigated through compliance offerings, which indemnify portfolio companies from misclassification. A layer of talent services provides a fleet of virtual recruiters to save managers time while allowing them to remain in control. The talent pool is composed of skilled independent professionals who freelance full-time, vs. staffing firms’ army of temps and in-betweens that are accustomed to on-site work and represent a flight risk if they’re presented with a full-time job opportunity mid-project.
How On-Demand Talent Platforms Drive Operational Improvements
In a recent Deloitte report (Private Equity: A New Era For Value Creation), researchers revealed that cost transformation and data-driven growth are now the main value drivers for private equity. Mr. Sanders said that underlying their analysis is a startling truth: Action items need to generate value in a short-ish window, but, at the same time, transform the portfolio company into a stronger organization that will sustain their advantages long after exit.
Mr. Sanders provides three transformations that on-demand talent platforms can drive:
1. Transformation of ‘The Work’
At PE portfolio company Flexera, human resources has shifted its mindset from talent acquisition to talent access. “A few years ago, at the recommendation of one of the operating partners, the company embarked with urgency to learn on-demand talent platforms, rethink the hire them full-time model of growth, and break down projects and programs into tasks that can be delivered by on-demand talent,” Mr. Sanders said. “They offered managers a budget for this as well as direct access to the platform (with guardrails, of course).”
As they gained confidence and proficiency in this model, he noted, managers initially saw cost savings as well as speed-to-hire metrics that led to even more enterprise-wide adoption. One of the key operational improvements they’ve seen is an increase in the velocity of work outputs, translated into faster project completion and an accelerated speed to market.
Mr. Sanders pointed to a specific use case: Flexera’s engineering team needed an influx of developers but faced a tight local labor market. They leveraged an AI filter to source talent quickly, with minimum management burden, and reported that on-demand talent delivered projects 200 percent faster than the norm. On-demand talent doesn’t serve as a replacement for dedicated full-time team members. In contrast, it serves as a load management solution as a company grows, building a “talent cloud” that extends their horizons in an agile way.
2. Cost Transformation
“Distinct from cost-cutting measures, this type of transformation changes the underlying structure of the talent burden and bakes flexibility and resilience into the operating model,” Mr. Sanders said. “It’s important to point out that for most portfolio companies, payroll represents 40 to 60 percent of their fixed costs. In a world where technology and facilities are becoming on-demand, traditional talent models are the cement in the budget. Because on-demand talent can be scaled up or down, they serve to variabilize a portfolio company’s cost structure. Given the never-ending uncertainties of today’s landscape, this should be a priority for any PE firm as they protect their downside.” In his book Post Corona: From Crisis to Opportunity, Professor Scott Galloway put it succinctly, if not humorously: “Cash is great for survival purposes, but the real gangster move is to have a variable cost structure.”
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“There’s also the issue of cost savings against traditional talent solutions,” Mr. Sanders said. “Not only did Flexera’s engineering team report more work velocity, they accomplished it at half of their normal cost. One reason has to do with getting rid of the middleman. Outsourcing firms mark up their talent two-4x. Staffing firms mark up their temps 75 percent or more, depending on the skill-set. And triple-digit markups are the norm for agencies and consulting firms.”
3. Digital transformation
In their groundbreaking book The Technology Fallacy: How People are the Real Key to Digital Transformation, researchers from Boston University and Deloitte linked a company’s success to its ability to strategically leverage external talent networks to resource workstreams.
Digital transformation — whether it’s data-driven decision support, ecommerce, or process automation — is not something you buy off the shelf like computers, buildings or vehicles, according to Mr. Sanders. “It’s the result of successful execution of dozens, if not hundreds, of projects across the enterprise, mostly completed by human beings. If you can’t resource the work fluidly, your digital efforts will move along slowly, impacting your sales throughput and exposing you to competitive risks.”
Mr. Sanders says to consider the case of Land O’Lakes, a member-owned agriculture cooperative. As part of their journey to digital maturity, they seek to use data to drive decisions along the value chain. “Their managers needed to compile thousands of online resources into a dashboard-driven database that analyzed performance results for seeds, chemicals, fungicides and herbicides,” he said. Using an on-demand talent platform, business manager Bruce Jump was able to source on-demand talent to do the heavy lifting and organize his algorithm-driven data resource. “What would normally take me weeks,” said Mr. Sanders, “they can get completed in a matter of minutes or even seconds.”
Talent Innovation Makes a Value Creation Plan Come to Life
It’s not news that private equity firms need to optimize their portfolio companies’ talent to drive value creation, Mr. Sanders said. The questions are, at what level and at what point of the deal cycle? “For decades, engineering the C-suite was considered the main role of the PE firm when it came to improving talent,” he said. “That’s why so many PE heads of talent come from executive search. But to drive enduring value creation, what’s needed is talent innovation that permeates the entire operating model — and doesn’t depend on executive oversight beyond sponsoring its adoption and scale.”
Private Equity International recently conducted a survey asking PE firm leaders about the difference between what they prioritized “day one” vs. what they would prioritize day one if the deal was done again. “Their lack of focus on human capital optimization was their greatest regret. Don’t let this happen to you in your execution of VCPs,” said Mr. Sanders. “The surging on-demand talent economy offers you a new way to drive operational improvement — quickly — at a time when doing so is increasingly challenging. It’s bringing in the cavalry for all of the knowledge work that’s running behind or being moved to the back burner permanently, thereby helping to unlock the full growth potential of your portfolio companies.”
Contributed by Scott A. Scanlon, Editor-in-Chief; Dale M. Zupsansky, Managing Editor; and Stephen Sawicki, Managing Editor – Hunt Scanlon Media