Digital disruption in the middle market

Companies are using leading-edge technologies to gain efficiencies, strengthen their targeting efforts and transform their businesses. As the Internet of Things, artificial intelligence, and advanced analytics become commonplace in the dealmaking landscape, what effect is this trend having on the middle market?

Points of discussions include:

  • Which non-tech sectors in the mid-market are being most impacted by digital disruption?
  • How are technology considerations affecting the strategies of private equity buyers?
  • How are mid-market firms responding to the increasing pressure to compete with venture-backed, high-tech start-ups?

Toppan Vite question: Which non-tech sectors in the mid-market do you think are being most affected by digital disruption? Which sectors would you say need to play catch up most to stay competitive? 5 dealmakers weigh in.

Steven Barth: Healthcare, insurance, and financial services are certainly at the top of the list of sectors being dramatically impacted by digitization. We are seeing a lot of money being plunged into Internet of Things (IoT) and big data technologies in these industries in order to drive more efficiency and enhance the targeting of customers. Fascinating work is being done in the insurance industry as old-line property and casualty companies try to get better data to lower their loss ratios and improve the behavior of their insurance customers.

The way in which insurance companies are fueling this innovation is interesting as well. In the past, insurers mostly invested their holdings in blue-chip stocks or the bond market, and maybe allocated a little bit to private equity. But now, a number of old-line insurance companies have said, “Look, we not only want to invest as part of our investment strategy but as part of our business strategy. We need to invest in more start-up, early-stage, high-tech companies that will help us drive better operational results and better portfolio results from our standard-line policies.” So they’re melding both strategies together.

James Cassel: Business transformation is a constant process. At our firm we have three main verticals, which are technology, healthcare, and aviation, as well as a general practice, and healthcare and retail are two areas that are being dramatically transformed by digital disruption. On the retail side, take a business like Blockbuster Video. If you were
a Blockbuster franchisee and you sold your business 10 years ago, you would’ve made a moderate return on your investment. If you held onto it until five years ago, you would’ve been on the verge of extinction. And today, I’m not sure that a single Blockbuster franchisee remains. What changed was the rise of services like Netflix and on-demand video – technology-based innovations that have destroyed that old business model.

Philo Tran: We are certainly seeing many companies think about how to use leading-edge technologies – such as IoT, virtual and augmented reality, mobile technologies, advanced analytics, and artificial intelligence – to transform their businesses. Digital technologies alter business processes but also create opportunities to develop new business models and new revenue streams. It’s not only about efficiency. I’ve seen the most interesting applications of digital technologies from low-tech industries. Augmented reality is used in manufacturing environments to guide humans assembling parts in a way that virtually eliminates errors.

The system tells the person which parts to connect and where, and if it sees the wrong part being used it will send a warning signal to the assembler. Connected aircraft engines are telling airlines when a part is about to fail and, thanks to the cloud, the system can find the closest supplier of that part and order a replacement. If you own a pool, your pool pump can detect when electricity rates are too high and shut off temporarily and your pool can even selfbalance the pH level without any human intervention.

Bryan Jaffe: Every sector is impacted by digital disruption, just as Philo said. Among those most impacted is brickand-mortar retail: whether it’s grocery, specialty, mass, or discount, as a class of competitors, they are all being disrupted by technology. And it is observable through a variety of metrics – for instance, commerce sales relative to retail sales, or stock prices of traditional retailers versus those dominating the ecommerce landscape. When you look at ecommerce sales as a percentage of total retail sales, the share of ecommerce sales is expected to grow on average at about 6% over the next five years, and that should continue for the foreseeable future. Additionally, if you look at Amazon’s stock price, which we consider to be the ecommerce bellwether, versus that of Walmart, the return scale is striking. Over the last five years, Amazon’s stock price is up close to 350%. In contrast, Walmart’s stock price is up 15% over that same period. This demonstrates how technology is not only disrupting a category but also shifting where value is created among classes of competitors.

Joe Manning: I would agree with Philo and Bryan – it’s tough to find an industry that is not being impacted by new business models that have some sort of software or digital component. For example, Riverside’s portfolio company Soothe is revolutionizing the massage industry via transforming how consumers hire and receive massages. Consumers can book massages through a smartphone app or website and receive a licensed massage therapist at their door in as little as 60 minutes.

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