Memo to the CEO: Lessons from Private Equity Any Company Can Use

The global credit crunch has left its mark on private equity deal volume. But the way private equity funds respond to massive market and economic uncertainties is instructive.

Now more than ever, PE funds are sticking with their winning recipe, which enables them to generate big returns from dramatic improvements in operations. The results speak for themselves: the top 25 percent of U.S. private equity funds raised between 1969 and 2006 have earned internal rates of return of 36 percent on average, through good times and bad. That's close to 10 points higher than the equivalent S&P 500 top quartile.

Private equity masters follow a basic set of disciplines that any senior executive can employ for similar results. Some of these lessons will sound familiar. Some may appear obvious. However, in our view, they are not being applied rigorously by businesses around the world. It is easier to do "fine" than to do the best a company can do. This pervasive disease of satisfactory underperformance can be cured by applying PE lessons.

Briefly, the six lessons are:

Define full potential: Top PE firms generate high returns primarily by creating operating value. They start by building an objective fact base. They scrutinize demand, customers, competition, environmental trends and the details of how money is actually made. Only then do they pursue a few core initiatives to reach full potential.

Develop the blueprint: PE blueprints are about action. They turn the few core initiatives into results, choreographing actions from standing start to the finish line.

Accelerate performance: Top PE firms mold the organization to the blueprint, use a rigorous program, and monitor a few key metrics.

Harness talent: Top PE firms create the right incentives for employees to act like owners, and they assemble decisive and efficient boards.

Make equity sweat: Top PE firms embrace leverage. This is perhaps one of the toughest PE disciplines to adopt, and one that CEOs and their boards should consider carefully, especially when credit is tightening. But CEOs, too, should get comfortable with leverage. Scarce cash compels managers to manage working capital aggressively, discipline capital expenditures, and work the balance sheet hard.

Foster a result-oriented mindset: This lesson is about creating repeatable processes that spur performance improvements again and again.

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Orit Gadiesh, chairman, Bain & Company, is an expert on management and corporate strategy. Hugh MacArthur, partner, Bain & Company, is the leader of the firm's Global Private Equity Practice.