Private Equity and Software Customers: Investing in a Product-Based Future

An article recently published in WSJ’s CIO Journal explored an ongoing shift in enterprise software away from a project-based approach and toward a product-based one.

What does that really mean?

When a firm’s CIO looks at a decision about enterprise software purchase and deployment as a “project” that needs to be completed, the Journal says, they’re thinking about it as moving the business toward a specific task with specific objectives. Expansive (read: expensive) resources would then be dedicated to ensuring that the project is kept on track. A “product”-based approach, in contrast, suggests a more future-facing vision –– one in which getting specific tasks done on time and on budget is still important, but isn’t the primary indicator of whether the software investment is really driving the business forward.????????????????????????

Rather than measuring against milestones (as project managers are often tasked with doing), product managers focus on creating enduring value for their customers. That value isn’t constrained within the parameters of an individual project.

I think the “product” mindset makes natural sense for today’s CIO. Even more importantly, it makes sense for the business unit leaders who are ultimately responsible for using those software products to bring about digital transformation within the firm. When considering a long-term contract with an enterprise software vendor whose product is integral to the future of their company, CIOs and business unit leaders need to know that onboarding and integration (technology, people, and processes) isn’t a one-time sunk cost, but a long-term investment that goes beyond a single project.

And what does that imply for how CIOs should look at competitive vendors? I think the answer here also needs to focus squarely on the future. The CIO has a vested interest in the financial health of their vendor, and as such, should care a great deal about that vendor’s future prospects even more so than its past.

That kind of crystal ball gazing isn’t easy. Typical financial statements can be a little less informative than you’d expect, and they are inherently more backward-looking. ?While it’s possible in principle to extrapolate leading indicators from publicly reported information, it’s not so easy in practice. Analysts make careers out of attempting to triangulate new bookings momentum and project a multi-year P&L by studying a company’s reported financial statements. It certainly isn’t something the average CIO should be tasked with.

In reality, the operational KPIs that are more indicative of a company’s trajectory (and consistent with a product-based mindset) aren’t easily available to the public market investor. Software customers could, at least in theory, glean into what’s ahead for their vendor by looking at what are called "leading indicators.' While those forward-facing metrics are sometimes available in public disclosures, it’s a rule, not the exception, to hone in on them in the world of private equity. ?

The leading indicators I tend to focus on include signals such as product roadmaps and investments, team continuity, market share changes, net promoter scores and future (not historical) cash flows. Other indicators like renewal rates, new bookings momentum, late-stage pipeline development and recent win-loss rates by product are similarly indicative of where the vendor is going rather than where it’s been.

I believe this is where private ownership can, under the right conditions, develop a bit of an edge. Rather than spending too much time analyzing historical financial statements, the management teams at Thoma Bravo portfolio companies implement operational KPIs that help ascertain where the business is going. Importantly, each of these metrics has an owner responsible for improvement. Our investment teams can focus more on these leading indicators rather than meeting short-term market expectations. We're empowered to understand and drive forward aspects of the business that would be seen as beneficial from the forward-facing, product-focused customer's perspective.

The Real Picture: A Comparison of Public Disclosures vs. Private Equity's Leading (Product-Based) Indicators

Private equity embraces this level of transparency as an integral part of its ethos — because it is precisely what determines our success as investors. We delve into granular detail to uncover efficiencies and help transform companies, cultivating a culture of efficiency and transparency regardless of whether they choose to remain private or decide to explore the public market.

But as I stated earlier, it would be unreasonable to expect potential customers to carry out the same kind and level of diligence that we do in managing our portfolio of enterprise software companies. Customers often don’t have the visibility nor the resources to evaluate the long-term health and prospects of the vendors with whom they are working –– let alone wade into the public-private debate, which can sometimes be a red herring. Instead, customers should be at liberty to concentrate fully on understanding the products and services they will receive in return for the price and terms of their agreement with a vendor.

To most CIOs, a company’s projects, and how it measures against those projects, are of little importance. In today’s rapidly advancing tech landscape, I believe CIOs should be thinking more like product people –– which just so happens to be how we try to think at Thoma Bravo.

If a CIO is considering an enterprise software product from a privately held vendor, we believe they can place their trust in Thoma Bravo companies knowing that our motivation is aligned with their own.