If you want to see the future of private capital operations, look at electronics and semiconductor manufacturing. Right now, private equity financial departments – watching over an enormous portion of the global market – are where computer chipmakers were in the 1990s.
At that time, Jerry Sanders, the founder of semiconductor manufacturer Advanced Micro Devices (AMD), was quoted saying “only real men have fabs.” A fab is a fabrication plant where semiconductors are made. In finance today, translate that to “real private capital leaders keep high-stakes fund services in-house.”
Sanders’s quote continues to be brought back up in technology, because now no computer or tech company manufactures their own chips in their own “fab.” Rather, the work is outsourced to specialists who only do that and do it better than anyone else, with incredible technology and deep domain expertise.
But in the early 1990s, outsourcing something so central to a technology company’s success seemed like a display of weakness. Nonetheless it was a growing trend, at a similar level of maturity then as fund services outsourcing in the private capital industry is today.
In technology no one accuses Apple, Tesla or Amazon of failing to be tech leaders because they don’t make their own chips or the complex electronics assemblies that use them. And no one accuses the great private equity names of today of failing to be financial leaders if they outsource fund services. But there is a difference in how the outsourcing is done in the production of electronics and how it’s done in private capital that illustrates more about where we’re headed next.
What contract manufacturers can teach fund services
What’s strange about private capital outsourcing is how little transparency there is, at least compared to electronics contract manufacturing.
Apple knows absolutely everything about the components being manufactured by TSMC and Foxconn in real time. That streaming intelligence includes when each element of the process is being undertaken. It includes whether deadlines and quality measures are being met right now. It means knowing the price of absolutely everything.
The data streams are detailed and relentless. The financial aspects, in particular, are called “open book manufacturing.”
In the meantime, private capital demands degrees of transparency, but not nearly as much, and the costs and processes are often unclear. The timing can shift. It comes down to emails that go out with documents, disappear for a while, and require follow-up nudges. While electronics manufacturers are streaming information, in private capital the workflows are static, sequential and frequently episodic.
Fixing that with new technologies for fund services is good for transparency that aids performance. Chat technologies are one example. Presentations at conferences orbit around things like data operations. This is good, but what exactly does it look like in practice when these technologies are implemented? And when there’s fuller transparency, what cultural things must change?
Chatting for efficiency and quality
Let’s look at a concrete example of how this can work.
Chat has become the sine qua non for firms whose workers have scattered across the country or beyond. In the software industry, this and wikis are how teams of engineers in India, Bulgaria, Texas and California develop products and get them to market.
In private capital, what if chat could be more than just a substitute for that quick conversation with a colleague down the hall? What if it could also become a ledger of approvals and rejections as well as a resource for professionals needing help with auditing, tax, know-your-customer and other requirements? What if, in short, it could become a process facilitator and compliance tool?
Chat applications today can include features, for example, where clients can initiate actions like capital calls, approve or give the thumbs down to reports and other documents that financial services firms generate along with other tasks. It can provide an undeletable, indexed and easily searchable record of communications for a host of purposes, including compliance, legal, sales and training. Newcomers need only look at the chat history to get up to speed.
It can also be tweaked to include other applications so that workflows become transparent and streaming data can be shared to reinforce behaviors for success, and quantifiable results.
Using chat in this manner, though, does require a cultural shift in the workplace. More on strategy for that in a moment. But tactically, professionals can exchange certain communications in specific chat channels consistently, for example, if they’re going to enjoy the benefits of the technology. They can separate chat channels used for business decisions and reportable actions from, say, those where colleagues discuss where everyone is heading for cocktails on Friday.
The shift takes some work. But it’s easiest when a financial firm partners with a service provider who already knows the ropes.
Private, but transparent capital
Let’s return to culture strategy. Private capital, after all, has a general culture that prizes the mystique of knowing things others don’t, or at least appearing to.
Within this context, for years private capital teams have been loath to outsource too many high-stakes workflows out of their middle and back-office – similar to Sanders and fabs in 1991. They have wanted to be able to check and confirm the quality of the work and have internal transparency.
Managers want to be able to walk down the hall. They want to engage in a quick conversation with an accountant or analyst. A chat over details is enough to obtain the information they need so they can confidently return to focusing on their job of achieving alpha for limited partners. Looking into the face of a colleague you’ve known for years is comforting and efficient.
Outsourcing needs to rise to that level. Integrating chat and compliance is one example of how technology can help. But it takes more than that.
Harvard professor Ryan Buell has researched and written on “operational transparency.” He has looked at how seeing an open kitchen in a restaurant, for instance, builds trust and intimacy with the meal that is cooked, plated and brought to the table. But businesses can fear transparency, Buell says. And he’s not saying they’re wrong, at least not initially. You have to be confident that your operations have nothing to hide, that the kitchen is actually well-run, clean and arguments aren’t breaking out in front of diners.
We’re moving in the direction of better finance department kitchens, now, because we have to. The line of thinking that high-stakes workflows should remain in the office was becoming less prevalent in recent years as office technology became more advanced. But the coronavirus pandemic and remote work stepped heavily on the acceleration pedal of change.
Few folks have been walking down their office’s halls lately. Couple those changes with cutthroat competition in the industry and downward pressure on fees, and it’s clear that financial firms have not only an opportunity, but an obligation, to rethink how their operations departments function, and the cultural changes required.
Operations must be exceptional to be as transparent as electronics manufacturing, and to be ready for the full value of things like chat communications. But if you encounter a fund services firm that can be that transparent technologically with streaming finances, you can also feel more confident that you can verify the quality required to make that work.
In the end, this is the logical destination for professional services work and financial management of private capital. And it’s the same destination across nearly every industry. Optimization, standardization and clarity breed better performance, which exerts pressure on the rest of the market. Combine that with the focused and customized service levels that private capital firms crave, and tools like chat enable, and you have a recipe for creating a new model entirely. The smartest firms are moving now, to become the equivalent of the Apples, Amazons and Microsofts of private capital.
Bob Chowaniec is chief operating officer and co-founder of 4Pines Fund Services.