The next frontier of value creation in private equity

Few PE firms systematically focus on pricing transformations, though such programs can create substantial value. Here’s how pricing value can be captured at any stage in the deal cycle.

Over the years, private equity (PE) firms have mastered the art of creating value for their portfolio companies through cost reduction, talent upgrades, and financial engineering. Moreover, they have built valuable experience in recognizing patterns that allow them to spot and invest in the best portfolio targets. In contrast, most PE owners do not display the same level of fluency or confidence in commercial productivity especially in pricing.

In our experience, commercial improvements such as those in a company’s pricing, customer and product mix, or sales volume growth can create tremendous value for both the portfolio company and the PE owner. Specifically, when PE firms tackle pricing in their portfolio companies, we typically see margin expansion of between 3 and 7 percent within one year. Factoring in potential pricing improvements can allow PE firms to be more confident in potential upside and differentiate themselves in competitive deals. The direct and rapid margin expansion from pricing transformation creates more value for portfolio companies and investors alike during the holding period. And highlighting a track record of both successful pricing improvements and additional pricing opportunities can result in a higher exit valuation.

To better understand the barriers that prevent deal and operating partners from using pricing to boost earnings, we recently surveyed more than 100 senior leaders from PE firms and their portfolio companies across Europe and the United States.

Our findings suggest that while respondents view pricing capabilities as highly valuable, they do not effectively build and use those capabilities to design and implement pricing programs. We also found that PE firms can maximize value by addressing pricing early, but value can be derived at almost any point in the deal cycle, from pre-deal diligence to the eventual exit.

How to create pricing value throughout a deal life cycle

Firms can maximize value by addressing pricing early, but value can be derived at almost any point in the deal cycle. More sophisticated PE firms and portfolio companies maximize value creation from pricing by focusing on different tactics throughout the deal cycle before the deal, early in the holding period, and pre-exit.

Before the deal: Sizing the opportunity

The first step is to assess the potential opportunity from pricing and build it into the upside case in a way that inspires confidence that value can be captured. Firms often have less than ideal data and compressed timelines, however, to assess potential opportunities. To formulate a robust perspective, experts need to hunt for patterns showing indicators that might help estimate potential value. Although these predictive indicators vary by industry, combining them with whatever limited data are available in the diligence stage and insights from management reports and interviews can help differentiate an investment case and allow investors to bid more accurately and competitively.

For those opportunities where a pricing program is likely to succeed, we typically see a 3 to 7 percent margin improvement for PE portfolio companies.

Solution design

For portfolio companies in their holding period, pricing can often be the right catalyst to spark margin and top-line growth. In these situations, after a four- to six-week phase to identify potential opportunities, management typically prioritizes a handful of pricing tools likely to generate the most value and explores how to capture that value sustainably. If the company at least started the process of developing a pricing road map as part of the 100-day plan. PE firms and management can then move right to determining the details of a pricing solution, calibrating, and accelerating the execution of that solution based on the existing road map.

The timeline of designing a pricing solution varies greatly by the complexity and starting point of corporate capabilities, but it can typically take three to six months; another six to nine months of concentrated effort is generally necessary before the results of implementation are fully realized.

McKinsey