Since private equity firms got their start in the US at the end of World War II they’ve created and unlocked untold trillions of dollars in value.

Private equity firms built and fine-tuned an almost sure fire system for unlocking value; find a target company that’s either distressed, bloated, undervalued, ignorantly fat and happy or ready to rock but without access to traditional financial resources to quickly scale and invest in them or acquire them driving the best deal possible. Then, send in a team of a few seasoned pros and some bold recent graduates from the nation’s best business schools to develop a business plan that maximizes EBITDA, replace the members of the existing leadership team if they don’t get on board the bus, execute the plan, watch EBITDA grow (hopefully enough to pay off the purchase price) and finally dispose of the asset and split the spoils five years down the road. The competitive advantage that private equity brings to the party is operational excellence and nobody has proven better at building lean, earnings spewing machines.

But, very soon, maybe even now, the operational excellence that gave private equity their big competitive advantage will no longer be enough.

There are three reasons:

  • The low hanging fruit, the easy turnarounds and the potential home runs are getting harder and harder to find. Driven by the twin forces of the dotcom crash and the worst recession (with the exception of the depression) in more than a century almost every business has already become operationally excellent or they’re gone. Layers of bureaucracy have been removed from almost every company, technology allows the value being created by every person, function and department to be measured in real time, every component, zig and zag and the quality of the supply chain is tracked to a millisecond and CRM systems make certain that the revenue and gross margin of every customer are being maximized. It’s getting harder to realize the magic of operational excellence when most or all of the work has been done.
  • Economic growth rates have been hovering around the two percent mark for a decade and it’s hard to find any reputable forecast that believes that’s likely to change in the foreseeable future. When you’re merely serving existing demand and haven’t cracked the code on creating demand it’s getting harder and harder to get top line growth and there’s only so much you can cut.
  • Most private equity companies grapple with growth because they’ve tried to get it done tactically. Advertising agencies get hired and fired, the position of CMO is created, eliminated or changed as the search is on for a wunderkind with a magic wand, there are prices increases to grow revenue or price decreases to grow share, endless attempts at brand extensions, new bundling models, shake ups in the sales force and changes in the way salespeople are compensated; all tactical response to a challenge that requires a strategy.

In many cases (they don’t like to talk about it but I work with enough of them to know) private equity firms have been forced to change their five year game plan as they struggle with how to make the revenues at the companies in which they’re invested grow enough to make them attractive for another private equity player to take them out, take the company public or find another means to dispose of the asset.

The challenge of building a group of companies capable of consistently increasing their revenues by mid to high single digits (or double digits) every year will continue to be elusive until private equity stops trying to fix the problem tactically and instead decides to create companies with cultures of growth to go along with the cultures of operational excellence they’ve produced. The challenge is that building cultures of growth requires leadership to let go of the very thing that made them successful; having very smart people making hard, cold, unemotional and solid business decisions. Cultures of growth require allowing the head to meet the heart and allowing IQ to meet EQ.

In studying more than 220,000 companies for eight books on growth, leadership, productivity, innovation, reinvention and speed my research teams and I have concluded that extraordinary companies who have mastered having both cultures of growth and operational excellence share five characteristics.

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