Buying a technology consultancy? Six things buyers should consider
Over the past two years, the number of deals in the consulting industry’s technology segment has spiked. Will Evans, Director at Arrowpoint Advisory, outlines why investor interest in technology consultancies is at an all-time high and six things acquirers should consider when exploring their next target.
The digital transformation revolution was well underway before the pandemic hit, but the onset of Covid-19 forced a rethink about the way we work and how technology can facilitate the ‘new normal’ of hybrid working. This accelerated the wave of transformation exponentially.
In fact, Statista estimates that the global spending on digital transformation technologies and services will hit $2.8 trillion by 2025, an incredible $1 trillion more than the predicted spend by 2022 year-end. But aside from the clear market growth, why are investors so interested in this sector, and what sort of questions will they be asking about the consultancies they may wish to invest in?
There is widespread acceptance that technology tools, platforms, products, and infrastructure can meaningfully improve how organisations perform. Digital transformation can take many forms, for example it might include moving data to the cloud, using technological devices and tools for communication and collaboration, automating processes, or capturing and using the vast amounts of data most organisations now sit on.
Technology transformation roadmaps incorporating these strategies seems to have been broadly unchanged in the face of political shock such as events in Ukraine, and remain a high priority. This has demonstrated the ongoing resilience of this sector.
The opportunities for consultancies client-side are vast, too. Implementing new technologies takes time – especially across large and complex organisations – and the technology roadmaps they have in place are long and wide-reaching. This means there is a potential for long term, multi-year engagements with clients on these programmes.
Indeed, tech-focused consulting firms are seeing record pipelines, and now need to be selective as to which opportunities they deploy their resource to.
Resourcing a skills shortage
In the face of exponential demand growth, there is clear technology skills gap that means finding sufficient resource can be a challenge. There is far more demand for candidates in the market than there is supply, so finding routes to scale up talent pools will be a key determinant in understanding who wins and who loses in this space over the next decade.
People operating at the ‘sharp’ end of technology are in especially short supply – those skilled in areas such as cloud engineering, data science, cyber and software development. This skills shortage, combined with wage inflation, is likely to be a key focus area for both investors and potential buyers as we move into 2023 and beyond.
Questions buyers should consider
With the demand-side box likely to be easily ticked, what are some pertinent questions investors are likely to be asking themselves, and why?
1. Can the target access the right talent to scale and meet the demand?
Demand alone is not enough – consultancies must demonstrate they can attract the right talent to support the delivery of a growth plan. With a tight labour market across the majority of the technology sector, consultancies who can successfully tap into the large graduate recruitment market will stand out, particularly if they can leverage in-house training abilities to get the recruits client-ready, fast.
Near-shoring or off-shoring is another well-trodden path to accessing new talent pools, and tried and tested models that can demonstrate limited impact on client experience are an increasingly sought after and more scalable model.
2. Can the target retain talent?
Another key consideration amidst the war for scarce talent is a consultancy’s ability to retain its valuable people. The employee value proposition is as important as ever, and culture, professional development opportunities, a focus on EDI (equality, diversity, and inclusion), and an attractive flexible working policy will be key factors in retaining talent.
Investors also see their capital structures, and an ability to incentivise key consultants with equity, as an invaluable lever to support this retention.
3. Can the target pass on wage inflation?
Wage inflation is undeniably going to continue across the technology market as the skills gap widens and demand shows no sign of letting up. The strength of the client proposition and mission critical nature of the transformation being delivered can therefore be borne out in a consultancy’s ability to pass these costs on to clients and maintain clear profit margins as a result.
A primary way to manage this inflationary environment is to deliver via programmes in a staged way, allowing for repricing more regularly to stay profitable, rather than a longer-term programme with a fixed price. The clear trade-off of this approach with long term contracts and revenue visibility is clearly a consideration not to be ignored.
4. Is the target a platform specialist or platform agnostic?
Consultancies which are highly accredited in particular platforms have received significant investor interest over in recent years, as this specialism underpins a strong barrier to entry and provides the business with a resilient market position. Indeed, many strategic acquirers consider platform specialists highly valuable to fill a gap within their existing business that can’t be built organically.
That said, a platform agnostic approach arguably provides greater long term growth potential, as these consultancies can offer clients a broader suite of platforms or products that best suit their needs. As the number of hyper-scalers (i.e. platform specialists) continues to increase, service providers who rely on a single partner – particularly if in quite a niche space – might come unstuck as their fortunes are resting on the success of the underlying platform.
5. How will demand evolve?
Covid-19 has clearly caused an exceptional and widespread requirement for all organisations to digitalise and transform the ways their people work, but is this growth a bubble or a structural long trend?
The general consensus is that many were already in the throes of widespread digital transformations pre-pandemic. Some sped up efforts already underway, while others implemented digital capabilities for the first time as a matter of survival.
Given the speed of technology advancement and the numerous business benefits to such technologies can deliver, including cost reduction, increased resilience and facilitating remote working, to name a few, it is clear that robust demand for technology consultancy is here to stay for the medium term.
This is further supported by the fact that the penetration of digital products and platforms still remains in the early stages, notably many consider the widespread migration to public cloud (which has tried and tested operational benefits) still have a number of decades to run.
6. How does the value cycle look like?
Large technology consultancies and systems integrators have never been more acquisitive, and it is increasingly inevitable that major corporates will continue to consolidate large parts of the market. Strong cash flows, low leverage and high trading multiples means they can justify high multiples where a capability is strategically important.
The key driver of value in a consultancy, given the skills shortages, is having a pool of talent that an acquirer cannot easily access through organic hiring, and investing to hire, train and retain technology talent should therefore be a key focus over the investment cycle.
Will Evans is a Director at Arrowpoint Advisory, the dedicated mid-market team of Rothschild & Co in the United Kingdom, and leads the consultancy M&A practice. He most recently advised the shareholders of Kubrick on their investment from Bowmark Capital, the founders of Newton Europe on their investment from ICG and the shareholders of Neueda on its sale to Version 1.