The Role of Digital Transformation in PE- Backed Carve-Outs

Private equity firms face unique challenges when carving out business units from larger organizations. Beyond the financial aspects, technology infrastructure and digital capabilities play a crucial role in determining the success of these transactions. In this blog, we will explore how digital transformation serves as a critical enabler for value creation in PE-backed carve-outs.

The TSA Challenge: A Necessary but Expensive Phase

When a business unit is carved out, it typically remains temporarily dependent on the parent company’s systems through Transition Services Agreements (TSAs). These agreements allow the carved-out entity to continue operations while building independent capabilities, but they come with significant challenges: TSAs often involve premium pricing structures that drain resources from the new company. The carved-out entity has minimal control over service levels and priorities, creating operational friction. These agreements typically have strict timelines with escalating costs designed to incentivize quick separation. Perhaps most limiting is the inability to implement meaningful changes during the transition period.

The ROI analysis consistently demonstrates the economic benefit of exiting TSAs as quickly as possible.

Post-TSA: The Digital Transformation Opportunity

Once free from TSA constraints, the carved-out entity can embark on true digital transformation. This isn't merely about replacing systems—it's about reimagining the business through a digital lens:

Three Key Focus Areas

1. Process Efficiency: Standardizing and automating core business processes becomes possible when freed from parent company constraints. PE-backed companies can implement lean principles across operations and establish metrics-driven performance management tailored to their specific goals, not the parent's priorities.
2. Optimized IT Landscape:The new entity can develop a cost-effective technology stack designed specifically for its needs. This means minimizing technical debt through modern architecture choices and shifting to cloud-based and SaaS solutions where appropriate, often reducing both capital and operational expenses.
3. End-to-End Digitalization: Creating digital interfaces for customer and supplier interactions becomes possible post-separation. The company can implement data analytics capabilities for decision support and develop digital products and revenue streams that may have been impossible or deprioritized within the parent organization.

The Digital Transformation Roadmap for Carve-Outs

A successful digital transformation in carve-out scenarios typically follows this trajectory:

Phase 1: Stabilization (Before or During TSA)

• Conduct technology due diligence to understand the current state and entanglements with parent systems.
• Develop a TSA exit strategy with clear milestones that prioritize critical functions.
• Deploy resources to maintain business continuity while building new capabilities, off-shore is always the most cost-effective.
• Establish interim solutions for critical functions that can't wait for full transformation.

Phase 1: Stabilization (Before or During TSA)

• Implement core ERP and business applications tailored to the carved-out entity’s specific needs.
• Establish independent data centers or cloud infrastructure designed for scalability.
• Build a right-sized technology organization with appropriate skills.
• Develop data governance frameworks that support the new business strategy.

Phase 3: Transformation (Value Creation)

• Redesign core business processes for efficiency and competitive advantage.
• Implement advanced analytics capabilities to unlock insights from newly independent data.
• Develop customer-facing digital experiences that differentiate from competitors and the former parent.
• Explore automation opportunities across the value chain to drive margin improvements.

Measuring Success: Digital Transformation KPIs

The impact of digital transformation in carve-outs can be measured through several key performance indicators:

• Reduction in operational costs as a percentage of revenue shows the efficiency gained through digital transformation.
• Improvements in process cycle times and quality metrics demonstrate operational excellence.
• Increase in digital customer engagement metrics points to enhanced customer experience.
• Growth in data-driven decision-making capabilities shows organizational maturity.
• Enhanced ability to integrate future acquisitions demonstrates scalability and flexibility of the new technology foundation.

Conclusion: Digital Transformation as a Value Creation Lever

In PE-backed carve-outs, digital transformation has evolved from being merely an operational consideration to a strategic value driver. By following a structured approach—moving quickly from expensive TSAs to stabilization with appropriate support, and then to comprehensive digital transformation—PE firms can significantly enhance the value of their portco investments.

The most successful carve-out owners use this period of organizational change as an opportunity to leapfrog competitors through digital capabilities, positioning the new entity not just as independent, but as a digitally-enabled market leader.