Harvard Business Review
The full version of this article is available on Harvard Business Online (subscription required).
The Idea in Brief
Going private was the making of auto parts manufacturer Accuride. For years, the enterprise had struggled as a unit within the giant Firestone Tire and Rubber Company (now Bridgestone/Firestone). Because Accuride’s business—making truck wheels and rims—was peripheral to Firestone’s core business, it found itself starved for resources and managerial attention.
Then, in 1986, Accuride was bought by a private-equity (PE) firm, Bain Capital. Freed from Firestone’s bureaucratic and budgetary constraints, Accuride took fast action. It saw that if it could become the dominant supplier to a few major customers, it would capture the lion’s share of the profits in its market. Because of the customized nature of its products, gaining a large share of a major buyer’s business would enable Accuride to spread its selling and tooling costs over greater volumes, producing much wider margins. And so Accuride quickly invested in a new, highly automated plant to increase its capacity and reduce production costs; the low-cost capacity enabled it to undercut competitors on the prices and terms offered to target customers. The competitors—big corporations like Goodyear and Budd—were caught flat-footed. As public companies directed toward quarterly earnings, they were unwilling to match Accuride’s investments, especially since the wheel-making business also lay outside their core operations.
With its focused strategy, Accuride flourished. In less than two years, sales shot up, market share doubled, and profits leapt 66%. When Bain Capital sold the company to Phelps Dodge just 18 months after buying the business, it earned nearly 25 times its initial investment. Since then, Accuride has continued to thrive, growing at a rate of 5% a year in a mature market throughout the late 1990s. Accuride’s story is not unique. The most successful PE firms spearhead such business transformations all the time. In the process, they create exceptional returns for their investors. How exceptional? U.S. private-equity groups like Texas Pacific Group (TPG), Berkshire Partners, and Bain Capital and European groups like Permira and EQT deliver annual returns greater than 50% year after year, fund after fund.
In studying more than 2,000 PE transactions over the last ten years, we’ve discovered that the secret to the top performers’ success does not lie in any fundamental structural advantages they hold over public companies. Rather, it lies in the rigor of the managerial discipline they exert on their businesses. Despite the widespread assumption that the stock market forces managers to concentrate on increasing the value of their companies, many executives of public companies lack a clear focus on maximizing economic returns. Their attention is divided between immediate quarterly financial targets and vaguely defined long-term missions and strategies, and they are forced to juggle a variety of goals and measurements while coping with contending stakeholders and other bureaucratic distractions. In stark contrast, the top private-equity firms focus all their energies on accelerating the growth of the value of their businesses through the relentless pursuit of just one or two key strategic initiatives. They narrow their sights to widen their profits.
In this article, we’ll look at four critical management disciplines we believe explain the successes of the leading private-equity firms. By adopting these disciplines, executives at public companies should be able to reap significantly greater returns from their own business units.