By Scott Johnson, CEO, SJ Partners LLC and ACG NY Board Member
I have taught a private equity course at my alma mater, Columbia Business School. One of my favorite slides in discussing PE firms is entitled “We are not Immune to this” and below the title is the cover of Michael Porter’s seminal business book, “Competitive Strategy.”
We as investors want our portfolio companies to have sustainable competitive advantages but we also have to ask ourselves about our own competitive advantages.
Portfolio company competitive advantages can include a brand, other valuable intellectual property such as a patent portfolio, unique R&D abilities, proprietary data, or a large and active community with a compelling network effect (defined when additional value is created as more users join the community – e.g., ebay has millions of users and a new entrant would seemingly be at a competitive disadvantage without such a base of buyers and sellers). Some companies can lead on cost which is sometimes possible with great economies of scale or a great supply chain. Often leading on cost can result in a downward margin spiral as others compete with you, a so called “race to the bottom.” This can be even more difficult if one is a middle market concern and not a Fortune 500 behemoth.
Price competition has its own analogue in private equity. One could potentially rapidly fill up a fund by outbidding others and competing on price alone. However, this then makes a good fund return obviously more difficult to achieve.
So what could be a PE sustainable competitive advantage? I think there are many. Some firms specialize in complicated transactions such as restructurings or ESOPs so they can lead in those technical areas. Others may indeed have a brand and outstanding investment professionals that potential companies find attractive.
SJ Partners, for example, focuses on our operating partner industry expertise and track record in both add-on and proprietary acquisitions. We have an industry specialization in consumer and services and work with a great set of operating partners who have that industry expertise. These partners who typically have run independent companies or Fortune 500 divisions help us understand sectors, provide the expertise and experience to effect positive change, and often are a source of deal flow. We also pride ourselves on growth by acquisitions (having completed fifteen add-on acquisitions including the latest one earlier this month) plus sourcing and closing proprietary deals (having closed eighteen of those).
So, if we demand our portfolio companies have sustainable competitive advantages, let’s make sure we as equity investors have our own.
About Scott Johnson
A board member of the Association for Corporate Growth’s New York chapter ,Scott Johnson is the founder and CEO of middle market private equity group SJ Partners, LLC (“SJP”). Scott was named the 2015 M&A Atlas Award Dealmaker of the Year and SJP won a 2015 ACG NY Champions firm of the year award. His is also the Chairman of portfolio companies Osmotics LLC and Best Made Toys LLC. Scott. For more information, see www.sjpartners.com.