The physical book has been updated to version 6 but this is the original version of chapter 7.

Meet the digital operating partner, the newest member of the private equity operating team. The digital operating partner is a senior business executive with an interdisciplinary background in business strategy, in science and technology and in hands-on operations. Like that of other operating partners, the role of digital operating partner is to increase the enterprise value of the PE firm’s portfolio companies. But digital operating partners do it in a very different way. The tools of their trade are high technology, and their job is to use IoT and AI to transform select traditional companies in the portfolio, piece by piece, into digital-traditional companies. The newly data-driven companies will then use technology to further innovate and invent their products, their operations and their business models.

This operational transformation is called smart digital transformation, and it represents a new angle for private equity at a time when fund managers are facing their highest competition. It’s a powerful angle that is new and produces a distinct source of alpha in an environment characterized by shorter financial levers, and less luck in arbitrage and discovering market inefficiencies.

ROLE

The enterprise value created by the digital operating partner hits the financials in three places. First, sales alpha is increased by using high tech to improve products, increasing market share, and to invent new products, increasing market size. Second, margin alpha is produced by using technical efficiencies to lower COGS and, to a lesser extent, OPEX, by improving asset utilization (people and equipment), production yield, capacity and performance. Together they raise EBITDA, which is always a good thing. And third, smart tech, when used in the way the most valuable tech companies use technology, can also increase the valuation multiple through the deployment of better products and new business models and other novel and disruptive strategies (Figure 7.1).

The digital operating partner is a specialist who can put smart tech to work in any sector where traditional, nontechnical companies are found. Although most in private equity think IT when they hear the word technology, it couldn’t be further from the truth, and for this reason it’s useful to differentiate between technologies. Low tech, which includes IT and business systems, is somewhat commoditized and therefore not in the realm of the digital operating partner because the opportunity costs are simply too high. Same thing for mid tech, which includes automation, RPA, digital marketing and ecommerce. A good rule of thumb is if you can find a local provider to implement the tech, then it is undifferentiated, is available to any competitor and yields commensurate returns. The digital operating partner’s domain is high technology, which includes the internet of things, data science (analytics and AI/ML), the digital twin, sensor fusion, additive manufacturing, AR and blockchain—tech that is highly specialized, exclusive and highly valuable.

Digital operating partners spend most of their time working outside of the buyout firm, and work in partnership with three very different groups of professionals: those responsible for investment, for management and for technology.

The digital operating partner works with the deal team throughout the life cycle of the investment. Together they work in diligence, and when an all-round strong asset is identified, they will develop the company’s digital investment thesis. They continue to work together during the hold period to smooth out any bumps in the plan. And at exit, they write the language communicating the remaining digital growth opportunities for the next owner.

Next the digital operating partner spends a lot of time on-site strategizing with select members of the portfolio company’s management team and engineering/production. Management, and whatever internal digital team there is at kickoff, is heavily involved in shaping the digital transformation plan.

And the last group of professionals the digital operating partner works with are the techies. They are selected from the digital operating partner’s proprietary partner ecosystem based on the specialized needs required to execute the requirements in the bespoke digital transformation plan.

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