THE BLOG
12/14/2012 01:25 pm ET | Updated Feb 13, 2013

The Fatal Blindness of Private Equity -- Where's Your Consumer Insight?

Here's a message to just about every private equity shop out there -- from the biggest on down. It's time to get your heads out of Excel and listen up. There's a really simple way for you to make the billions in all your funds work smarter, harder and faster.

Take a look the consumer. A good long and continuing look.

Consumers drive more than 60 percent of the economy, and you're making investments in consumer companies all the time. Yet it's the rare PE firm that has anyone roaming the halls, anyone caffeinating themselves at the Keurig machine during deal-related all-nighters, who has any consumer marketing experience.

Scary. But true. I did some checking on the executive biographies at KKR, Cerberus, and many others -- and what I found was a parade of one strictly financial dude (and they were mainly dude) after another. No one who worked at high levels of brand strategy or consumer research or, God-forbid, creative development. No one with a deep and current understanding of the profound changes roiling the consumer economy -- the way that social media is changing the game and rewriting the power equation between brands and customers. No one watching and analyzing the ascendency of women. The complexities of marketing to millennials.

None of that is part of the private equity ecosystem of understanding. It's as if deconstructing the numbers, independent of the living, breathing, decision-making consumers who are responsible for those numbers, is sufficient.

For decades, private equity has been structured and operated based on an input and analysis apparatus that spends vast amounts of time and money on financial sensitivities, and virtually no time on consumer sensitivities. Yet the reason many if not most acquisitions of consumer companies fail is not because of a mathematical miscalcuation, but a human miscalculation.

The p/e firm failed to understand that the consumer trends were rushing in another direction. That the strength of the brand was over-stated and it was rotting slowly at the core. That the simplistic idea of line-extending the brand into new categories was far more fraught and complex than they had anticipated. That the retail reality was misjudged. Or a myriad of other marketplace truths, trends and stresses that only someone with a deep understanding of consumer marketing could provide.

Let me be clear -- I'm not talking about oil and gas or real estate or other categories where consumers don't determine the eventual success or failure of the deal. Although, in many strictly b2b categories, consumers are still the ultimate decision-makers. (Who shops at malls -- real people or CFOs?) My focus here is largely on deals that involve consumer businesses -- CPG companies, restaurants, retail, hospitality, gaming, apparel, travel, service businesses -- the list rolls on.

I once asked someone I know in the p/e world if they ever go out and do their own independent consumer insight research before making an acquisition, and he looked at me like I was crazy. We make deals based on the numbers, he told me. As for brand value, it's enough for them to toss out platitudes like Company X is a "strong brand with an excellent consumer franchise." That's the level of sophisticated inquiry that goes on.

Yet on the financial side, they're busy running dozens of different models and sensitivity analyses peering into murky depths of IRR, manufacturing costs, property taxes and the like.

There are exceptions. One of them is Centerview Capital, which is run by Jim Kilts, who had a brilliant career as Vice-Chair of P&G and ran Nabisco and Gillette. But Jim is a shining exception.

It's not too late for private equity to expand its aperature to include a rich understanding of the consumer world. If I were an investor in private equity, I would demand it as a fiduciary obligation of those investing my loot. Maybe the problem is that consumer insight isn't quantifiable, and financial people are only comfortable when they can toss around metrics. What's the ROI? What's the EBIDA? What does price-per-square foot of the manufacturing facilities look like? So let's start to metricize consumer insights. Why not create a series of ratings and numbers that measure attributes like trend-correctness, female-friendliness, social-media acumen, brand elasticity and the like. It's imperfect, and won't replace the insight of informed and intuitive judgment, but would be better than what's happening now. Which is nothing.

According to a survey in the Financial Times, one-in-five private equity firms is headed for bankruptcy. A better understanding of the consumer won't prevent them all, but it will save billions of investor money. And more important, thousands and thousands of jobs. So beyond providing a better return to investors, that would actually help improve the image of private equity firms. But that's another story. Which I'll get to.