Implications for Practitioners

While this study is primarily directed toward making a contribution to academic research, it also offers tangible implications for practitioners, notably for those who have touch points with the PE approach.

7.2.1 Implications for Investors

Chief Investment Officers of banks, charities, family offices, foundations, governments, insurance companies, pension funds, or university endowments, typically do not have the necessary resources in-house to manage investments across their whole range of targeted asset classes. Though direct investment or co-investment activity of e.g. pension funds has gained momentum recently, often Chief Investment Officers have to invest indirectly through external investment managers, such as PE firms. Picking the right investment manager can be tricky, a fortiori when the PE firm is undergoing a major business model transformation. Will key persons be distracted? Whose interests will the PE firm put on top? What implications will this have on investment returns?

While this thesis is primarily concerned with strategy analysis on the corporate level of the PE centered investment firm, it also distills new relevant considerations allowing investors to scrutinize the stability and the economics of the PE platform. A well-balanced PE centered investment platform can actually be interesting for investors, e.g. if the traditional PE assets can benefit from information sharing advantages or procurement cost advantages, notably cheaper and better access to the production factor capital. At the same time investors can benefit from the findings in that they create more transparency on distinct PE business model architectures which can misalign interests between investors and other stakeholders.

Overall, this study attempts to upgrade taxonomy and to establish a common conceptual frame for conversations between investors and other stakeholders of the PE model, notably owners, which hopefully can facilitate a better rectification of interests.

Investors can also benefit from the study’s contributions in situations where they pursue direct investments or co-investments. For example, between December 2009 and August 2010, the $94b pension fund Teacher Retirement System of Texas invested $160m alongside KKR, Warburg Pincus and Apollo Global Management.⁴⁸

The more investors move into this direction, i.e. the more they expand their range of activities by integrating traditional PE activity, the more they can benefit from a better understanding of strategy and business model matters on the corporate level of a PE centered investment firm. Strategic forays of e.g. pension funds or sovereign wealth funds into PE can be seen as strategic vertical integration moves. In other words, the business models of investors, notably those of captive or sovereign investors, actually converge with the PE centered investment firm model.

Other pension funds also expressed their interest in moving more toward co-investment and direct investment, such as the California Public Employees’ Retirement System, being motivated by the opportunity to create more individualized structures with lower fees and more customized portfolios.

7.2.2 Implications for PE Centered Investment Firms

This is the first controlled public study which investigates strategy on the corporate level of the PE firm. The preparatory research groundwork is based on a new strategy approach, conceptually comprising a considerable though barely understood part of the PE universe.

While the prevailing view perceives PE firms in a rather undifferentiated way, this study offers a new strategic coordinate system, allowing for a differentiated analysis of a variety of PE firms’ strategies. This refined conceptual grid also allows for an investigation of current puzzles in the evolution of the PE sector, notably the branching out of traditionally monolithic PE firms into new areas such as debt funds, hedge funds, underwriting, or advisory.

Based on strategic grouping approach, this thesis unveils generic competitive strategies of PE firms and describes each strategic pattern in detail. The evidence suggests that there is no

48 See http://www.privateequityonline.com/Article.aspx?aID=5815&article=55443.

one best strategy in the PE sector. Various strategies can lead to success. Similarities between firms are captured within group structures and are formalized by mobility barrier differentials between groups. The existence of these barriers enables strategies to be sustained over time, offering explanations for persistent performance differences. The positioning of the strategic groups in various strategic sub-grids provides new powerful descriptive frameworks for strategy analyses while allowing for prescriptive conclusions and portrayals of future competitive dynamics. The strategic grouping approach also allows for a richer portrayal of different types of entrants and paths of entry.

This study also provides a new strategy framework for the analysis of corporate strategy of the PE firm. With an increasing horizontal and vertical convergence of financial intermediaries in the alternatives space, it will become increasingly challenging for the leadership of a PE firm to conceptualize essential strategic questions.

Based on expert interviews with senior investment professionals from recognized PE firms, this study synthesizes primary drivers whose efficient trade-off determines the optimal corporate boundary of the PE centered investment firm. This study is the first known attempt to make tacit knowledge of senior investment professionals on corporate strategy of the PE firm more tangible.

While this study covers a quite broad range of topics related to the strategy of PE, it should be acknowledged that strategy is not everything, nor are strategic groups or corporate boundaries everything related to strategy. The contributions of this thesis can merely complement other approaches to strategy.

7.2.3 Implications for Portfolio Companies

For management teams of portfolio companies a better understanding of the strategic thrusts and business model characteristics of their financial sponsors can empower them to be more aware of potential linkages between their activities and other activities or businesses of their parents, both on the corporate level of the PE firm and on the portfolio company level.

Depending on which strategy and business model the potential parent pursues, the range of value enhancing opportunities for the portfolio company changes respectively. For example, having a platform specialist as a parent might offer great opportunities for the portfolio company with respect to ‘buy and build’ initiatives. However, perhaps the portfolio company does not need ‘smarty-pants’ strategic ideas from a sector focused parent and rather seeks the partnership with a more impassionate owner who can effectively lead the refinancing of maturing debt facilities in the most efficient way.

In other words, a deep understanding of the motives and capabilities of their financial sponsors can allow portfolio companies to better and more proactively utilize the platforms which their parents, sometimes unknowingly, possess.

7.2.4 Implications for Regulators

For regulators this thesis contributes toward their understanding of the heterogeneity of the universe of established PE entities. Due to fairly extensive research over the last two decades, our understanding of causalities between the traditional monolithic PE model as a niche financing technique and its economic impact has made good progress, presumably helping regulators in making their decisions.

However, this thesis suggests that PE as a multi-layered PE centered investment approach is barely understood, let alone the role of PE as a management approach of governing investments in the market for corporate control. Niall Ferguson, one of Britain’s most renowned historians, pointed out that lessons from history suggest that financial species are vital to creating the wealth of nations (Ferguson 2008). Until we have a better understanding of the complexity of the PE approach, from a society’s perspective it will be difficult for us to understand its economic role and to incentivize it appropriately.

The Gramm-Leach-Bliley Act of 1999 was the regulatory capstone repealing the Glass-Steagall Act of 1933. The debate, whether the Glass-Glass-Steagall Act was justified, or whether its repeal, the Gramm-Leach-Bliley Act, contributed to the recent turmoil in the financial markets is ongoing. At the time of writing, the ‘Volcker Rule’ was one of the prominent tips of the iceberg of this debate, being part of what US President Barack Obama called the toughest financial reforms since the 1930s. A regulatory revamp framed by the Volcker Rule wants banks to unwind their principal investment activities such as hedge funds and PE funds.

It is yet unclear how many years the banks including Goldman Sachs, Morgan Stanley, J.P.

Morgan, and Citi, will have to cut down their stakes in affiliated hedge funds or PE funds so that their direct or indirect exposures do not exceed 3% of their capital.⁴⁹

This thesis synthesizes knowledge about both the origin and about current distinct forms of PE activity. It appears legitimate to suggest that our economy and society can benefit from increasing regulatory heterogeneity considering different types of PE activity. The evidence suggests that the bundling of financial products and services is not necessarily detrimental to the stability of a financial system. In fact, this thesis shows where such bundles can create economic value from society’s perspective, for example through the more cost efficient facilitation of information and capital flows. At the same time this study outlines the challenges and risks of bundled models, notably with respect to conflicts of interest and wealth transfers. Overall, the knowledge presented in this thesis can further empower regulators to design more differentiated and more effective regulatory architecture.

The investigation of the origin of PE, of its break-up and of its renaissance in the 20^th century (see chapter 2.1), implies that between the 1930s until the 2010s the PE related regulation has completed one full, almost century long, regulatory cycle in the US.

49 See http://www.businessweek.com/news/2010-06-29/volcker-rule-may-give-goldman-citigroup-until-2022-to-comply.html.