Marketing as a discipline has always fascinated me. While I was doing my MBA, I was naturally attracted to the marketing stream. Admittedly, one reason was that marketing courses involved less work, less quizzes and more projects (and less competition from the toppers, who were mostly focused on finance). But I later realized that many of the projects we did at that time were actually quite useful and fun! Since those days, up until my current role, I have been a marketer - from detergents, shampoos and soap to steel rods to aerated drinks to pharmaceutical drugs – I have done my share of branding and product pushing!
There is a stereotype of the quintessential marketer – one which is associated with advertising or fast moving consumer product categories. People are surprised when I make the simple assertion that, boiled down to its essential core and after removing all the financial jargon, private equity investing is essentially a marketing job! Yes - there is brilliant marketing work being done in the private equity world, something that gets inadequate attention and appreciation! Let me provide the basis for my assertion.
The private equity process
The private equity process, at a basic level, is about finding the right business to invest in, helping it grow, and then selling your stake in it for a profit. As the first step, the private equity investor needs to find an interesting company for investment. In most situations, while there are benchmarks, the price is based on future growth and past performance – and can be quite subjective. (Most PE teams will vouch for this, as we often are surprised by prices that others are willing to pay, the logic for which is not clear to us!). The PE investor buys at an entry price based on the marketing story of the investment banker and the promoter/seller (he judges the price versus the quality and brand attributes of the ‘product’). A few years later, the PE investor sells his stake to another buyer at (hopefully) a higher price.
This involves all the aspects of marketing again – assessing the quality of the product, targeting the right kind of buyer, and then selling him the product/ brand story that enables the best price! It’s all marketing at its basic level – and performance is determined by how much better was your marketing story at the exit versus the story you bought, and how much did you improve your product (invested company) over the hold period!
Taking this analogy further, viewing private equity through a marketer’s lens can provide some interesting insights and lessons!
1. You cannot sell a bad product at a profit (beyond a point)!
A basic marketing principle is that intrinsic quality of the product is critical. Without this, no amount of advertising or selling efforts will get you a desired price premium (indeed, you may have trouble making a sale at all!). People regard Procter & Gamble as a great marketing company – they sell most brands at a premium, and still manage to gain/maintain their market shares across categories. Yes, P&G is a great marketer – but not only in terms of the conventional ‘visible’ parameters of advertising/communication. I think they are successful because they actually MAKE great products.
On the average, the quality of their products is higher than the nearest competitor – most P&G products would win in a ‘blind use test’ versus their nearest competitor – and despite that they keep improving quality continuously! P&G is then able to do all the communication/branding and charge a premium. In fact, once you have managed to design such great products, you don’t really need much selling effort!
Similarly, in private equity, the business you invest in is akin to the basic product. Once you have identified a great business (you could define its quality in terms of management quality, net margins, return on capital, growth potential due to entry barriers or industry structure, execution, timing/leadership position etc), you fundamentally improve your chances of success! Yes – you could still get the pricing wrong and buy at a higher price (the seller may be a good marketer at this stage!), but if you are a good marketer, you could always sell the business story of a strong business even better in the future! At least you have that chance, since the product is fundamentally good.
The reverse – buying bad products at a discount - just does not work. We have seen many funds take chances by investing in bad businesses (buying a fundamentally bad product – in terms of margins, leadership, or return on capital), sometimes at a discounted price. This is a risky strategy, unless you can fundamentally change the business as an investor (unlikely in most cases). Think about it, you are getting a discount BECAUSE it’s a bad product! These products will get sold from investor to investor, and at some point the reality will hit everyone – that fundamentally, the business is BAD! You don’t want to be the one holding the business at that point. In these businesses, the last one holding the can is usually the loser – in many cases, it may well be the public after an IPO!
Also, beware of ‘over-marketed’ products, even if they are of great quality. The term ‘momentum investing’ is used in the PE world in a related context – when the investors probably knows that even if the business is good today, the current price/value equation is not really making sense. But they invest ‘hoping’ that common sense does not prevail till the time they exit! They are counting on the marketing momentum built for the product/ industry to help them at the exit as well – not realizing that that the product may already have been hyped beyond reason! This is high-risk investing.
2. Branding and targeting can get you a significant price premium (assuming you have a decent product)
Branding implies all tangible and intangible associations that you build around a core product, helping to differentiate it from competition. As Jack Trout (the management guru of the Ries & Trout ‘Positioning’ fame) puts it – ‘If you are not different, you better have a low price’! Private equity players can and do create significant value by focusing on this aspect – they could build the branding story around leadership (in the overall industry, or in specific categories), around the team quality of the business, around the systems and processes installed in the business, around ethics and corporate governance etc.
One thing that many PE investors forget is that the marketing story today (based on which they bought the business – looking at the next 3-5 years) could be VERY different from the marketing story that they will have to develop to sell the business (since that will need to focus on the subsequent 3-5 years – which is now 6-10 years into the future, and could well have a very different set of possible buyers and buying criteria!).
A case in point is investments by PE players in the SME/mid-sized companies - they are probably buying stories of companies that could do an IPO in 3-5 years (based on today’s IPO data), but my sense is that the way the IPO markets are developing, getting a Rs. 400-600cr revenue business to IPO in 5 years may not be easy any longer. Thus, they would be better off thinking of marketing the company to a different target audience – a larger strategic who may need scale for an IPO, or even larger PE funds. If done well, this could get them better pricing! Before deciding what kind of brand to create, it’s good to have some sense of who the target audience (or potential buyer) could be.
Thus, if you are building a company for a strategic buyer, it makes sense to position the ‘brand’ towards what is important to them. Multinational buyers prefer companies with complementary businesses, with strong systems and processes, with most government/ approval hassles taken care of. Indian corporate buyers prefer large, high growth businesses that complement theirs – with the management team willing to move out if required. The public (IPO) markets like market leaders, or significant market shares, and strong track record of profitability and growth.
A significant area of value-add brought by PE investors is a proper assessment of which buyer would pay the best price for a given business. Targeting involves getting into the shoes of potential buyers, and really understanding their needs many years before the sale happens!
3. Brand extensions can work, but be careful how much you stretch
Brand extensions are a time tested way of leveraging the equity of an established brand to newer areas. Borrowing ready equity from a brand reduces overall marketing costs, and enables more profitable growth. The same argument when applied to businesses shows us that a specific set of skills/capabilities can be extended over newer business areas to get higher growth.
There are many such examples in PE investing, where a company good at a core skill is encouraged to expand that skill set in another industry or product market. (e.g, Engineering-Procurement-Construction/EPC skill in material handling, extended to power plant building, small boiler expertise extended to super critical, EPC in telecom towers extended to EPC in electrical transmission and distribution etc.). However, this can be successful only in related areas, and also within certain limits. Over-stretching will damage the brand equity.
Many private equity investors have bought into this story – ‘current business doing well, but growth tapering out now - more investment required to build the next platform of growth (extend the brand)’. Firstly, try to avoid these growth stories as far as you can – ideally one should invest in a proven growth business. But if you like the story, be doubly sure that the brand is getting stretched in the right ways, and to the right extent.
In my experience, most unpleasant surprises at operations in an invested company typically arise around the ‘brand extension’ stories – where the applicability of the same skill set was over-estimated, or extent of competition was not understood properly. The worst examples we see are where strength in India is stretched to other geographies! In these situations, if things don’t work out well, the core business (core brand) could also suffer and decline!
4. The ultimate investment – a great product that is under-marketed today!
The holy-grail in private equity investing is finding a great business which is under-marketed or under-appreciated today. Help build that over a period of time (maybe on specific dimensions, keeping in mind the end buyer), and then market it to a group of buyers. That is the best (but increasingly becoming the toughest) way of creating value and getting multi-bagger investments!
Why is this so difficult? Most Indian promoters are very smart businessmen, and even better marketers. In addition, investment bankers add their bit to the marketing and pricing story. And finally, there is investor crowding, where many (and many nave) PE investors are crowding and bidding for investments. Having said that, the best deals even today are of this nature – and most good funds have at least one such deal in their portfolio!
In summary, looking at private equity from a marketer’s lens can give you some interesting perspectives. Is the core product quality fundamentally good? Are you buying into an ‘over marketed’ category? Can you visualize a potential target buyer for the future, and can you build the right brand for him? Are you buying into a brand extension story that you are comfortable with? In the end, it’s all marketing!