More often than not the companies we work with in Private Equity are not unique. Most of these companies, the vast majority, really, do not conform well to the big strategy concepts implying uniqueness: unique positioning, value proposition, blue ocean, etc.
This is not to say that they are not successful. On the contrary – they are. Most of the research conducted on private equity portfolios shows that these companies perform better than the average and often better than public companies.
Intuitively in private equity we all know that this is true: the vast majority of portfolio companies are not unique and at the same time perform well; they do not become large multinationals, but do generate value or EBITDA growth for their owners.
If they are not unique but successful, how does that work? Without further theory, let’s take an example. Let’s look at a typical such company. They make chemical specialty products. For this particular company, the following things are true:
- the company sells specialty materials in limited quantities
- these materials are developed for particular clients or group of clients (segments)
- the materials fit in larger products and do not cost much compared to the cost of the total product (usually between 1% and 2% of the total cost)
- the material is critical – it has to properly work for the whole product to work. When it fails the whole product fails. The material must perform in a very demanding environment.
- a typical specialty material takes generally 12 to 18 months to develop
- a typical specialty material is developed in conjunction with the R&D or the Engineering department on the client side
- price is usually agreed on with the R&D or the Engineering department on the client side
- once in production, the client’s purchasing department places orders, but does not negotiate the price
- more often than not, the company is the sole supplier of these materials to its clients
- the company’s clients span several industries: oil & gas, transportation, energy, safety, marine, military, etc.
What we are describing is essentially a specialty manufacturer. You can call it niche, high end, short/medium series, non-standard, tailor-made, engineering oriented, R&D driven, etc. Many companies claim these qualities, but an investor has to be careful and make sure that they are real.
Back to the point of uniqueness: these companies are not unique. There are at least several of them in any given industry and any given segment. They are distinct from standardized product companies. They exist in packs, large packs sometimes, of multiple similar companies.
They are not unique, but they are successful. Their sales are stable and predictable because the product lifecycle is long enough. Their growth comes from developing new products for their client base or from gaining new clients for existing products or applications.
In other words, these companies are well adapted. There is an evolutionary logic to it.