Definition
Operational Improvement refers to strategic initiatives and tactical changes implemented by a company’s management or owners (such as a Private Equity firm post-acquisition) to enhance business performance, increase efficiency, drive growth, and ultimately boost profitability and enterprise value. It focuses on improving how the business fundamentally operates, distinct from purely financial engineering levers like Financial Leverage.
Operational improvements are a key component of active ownership and are central to Value Creation strategies, particularly in LBOs.
Key Levers and Areas of Focus
Operational improvements can target various aspects of a business, including:
- Cost Optimization & Efficiency:
- Supply chain rationalization and procurement savings.
- Process improvements (Lean, Six Sigma).
- Headcount optimization / organizational restructuring.
- SG&A expense reduction.
- Revenue Growth & Commercial Excellence:
- Pricing strategies and optimization.
- Sales force effectiveness and expansion.
- New product development and service offerings.
- Market expansion (new geographies or customer segments).
- Improving customer retention and value.
- Working Capital Management:
- Optimizing inventory levels (Inventory).
- Improving collections (Accounts Receivable).
- Extending payment terms (Accounts Payable).
- Capital Efficiency:
- Optimizing utilization of fixed assets.
- Rationalizing Capital Expenditures (Capex).
- Management & Organization:
- Strengthening the management team.
- Improving reporting, controls, and IT systems.
- Enhancing company culture and talent development.
Shift in Private Equity Focus
Historically, private equity value creation through operational improvement often emphasized cost-cutting and efficiency gains. However, as noted by Hugh MacArthur (Bain & Company), there has been a notable shift in recent years. Increasingly, the primary driver of value creation within operational improvement strategies for leading PE firms has moved towards top-line Revenue Growth initiatives. While efficiency remains important, generating sustainable revenue growth through improved commercial strategies, market expansion, and innovation is often seen as having a greater impact on exit valuation in the current environment.
See also: Value Creation, Private Equity, Leveraged Buyout, Revenue Growth, Cost Optimization, Net Working Capital (NWC), Target Company