Historically, private equity firms have relied on merger and acquisitions to drive growth. But as the M&A landscape continues to evolve and competition for deals tightens, more PE firms are turning their focus to an emerging, but often overlooked, engine for growth – New Product Development (NPD).
If done correctly, NPD can lead to higher M&A valuations and earlier exists, driving organic growth and diversification in a way that bolt-on acquisitions often don’t achieve for PE firms. Contrary to popular belief, New Product Development can be done quickly and easily, but it does require operating discipline.
Targeting a modest goal of adding two or three new products per year can add a sizeable boost to the bottom line. The good news is that if you are not doing NPD, then it is the low-hanging fruit you need to grow your investment. Here are some key steps you can take to achieve this growth:
· Dedicate a Team: Break out and dedicate a small portion of your team (marketing and technical) to NPD only. Don’t let them get distracted with day-to-day customer support. Studies show that shifting as little as 15% of your market and technical teams is sufficient to drive growth.
· Analyze: Typically, a healthy, growing company that leads in many of its markets will have at least 25% of its annual sales from products launched in the last five years. Capture these figures for your own PE acquisition, being careful to only count products that bring new customers to your existing market, or that open new markets to you. This is an important metric to add to quarterly and annual updates.
· Adopt an NPD Process: Implement a simple phase-gate NPD process with a decision team to support and guide the project team. The decision team typically includes senior executives who provide resources (people and money) to a project team that has developed a compelling business case that fits the company’s strategic growth plans. It ensures you limit your spend on resources and capital until you fully understand the risks and rewards of the new product opportunity.
· Focus on Markets, not Single Customers: Target developing products to key markets that support the strategic direction of your company. Avoid single-customer products that will only bring incremental returns on the investment, or products that are outside your capability.
· Think Big, but Start Small: If you are new to NPD, don’t try to bite off too big of a chunk right off the bat. Start with a small project that has a clearly demonstrated need in the marketplace, and that is not too complex or expensive to produce. Save the big ideas for when your team and process are humming.
I recently worked with a PE-owned technical company that for decades was a market leader. For the previous five years, however, they had suffered flat growth and shrinking margins, as price pressures built up and eroded their market leadership position. A cursory audit of their NPD process revealed that they had not developed a successful new product in five years! In fact, the majority of their research and development team was supporting current customers with existing products. We followed the steps above to implement an NPD growth plan. Over the next four years, they experienced a 40% boost in sales due to new product introductions with double the gross margins.
As competition in the M&A world continues to tighten, adding or improving an acquisition company’s NPD function can offer real competitive advantages and lead to better returns post-transaction. In addition, when it comes time to sell, having a demonstrated track record of NPD growth will result in faster turnarounds at higher multiples. This can then lead to an improved ability to raise capital for future investments.