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Weekend Analysis

Gen AI’s prompt for GPs: Are you a disruptor or a disruptee?

Private equity managers face a reckoning over which assets are winners and which are losers as artificial intelligence upends the marketplace.

For investors, the conversation around generative AI has rapidly changed.

Questions about the technology’s impact that seemed abstract and distant 18 months ago—"Will AI impact the value of my portfolio?” or “How will it shape investment decisions?"—are now real and present.

For fund managers, particularly venture capitalists, the gen AI boom has surely created new investment opportunities. But it also has spawned a whole new set of risks for business models that face being upended by a radical wave of innovation.

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Many investors suddenly regard gen AI as a top consideration to take into account when looking at how to manage their portfolios and perform the due diligence needed for future investments.

Although digital disruption is nothing new, the breathtaking pace of AI innovation promises to be challenging and far-reaching for a long-term asset class.

Narry Singh, a partner with consulting firm AlixPartners who advises clients on digital transformation, says that GPs approaching a potential deal are increasingly having to ask themselves whether they are buying a disruptor or a disruptee.

“It is an additional lens that was always there with digital disruption,” Singh said. “But now the volume of AI and generative AI disruption has become very high.”

For many companies, the advent of gen AI has had a significant upside. Singh cited some of the work his firm has done with large PE firms investing in US retailers, where the use of gen AI alongside machine learning and other automation has helped increase sales in stores. In some cases, he said, AI technology has helped increase online retail traffic by as much as one-third.

Not all sectors are being equally affected.

AI’s impact is existential in legal services, accounting and some healthcare services, Singh said. For this reason, a large part of the work being done by consultants is in assessing the extent to which gen AI will leave a mark on each company in the portfolio.

Richard Lichtenstein, Bain & Co.‘s chief data officer for PE, said Bain evaluates client portfolios to identify gen AI-related risks and opportunities. In each case, companies are placed in one of three categories with widely varying consequences for each group.

The first group are “revolutionary” companies that comprise about 5-10% of portfolio investments—companies seeing their business models upended.

“These are contact-center businesses, translation businesses, creative businesses,” Lichtenstein said. “Businesses where they are going to have to change the way they do business pretty fundamentally to be successful in the future.”

A company that could fall into this category is Oregon-based InflowCX, a Gemspring Capital-backed provider of customer-support, or contact-center, services that has sought to leverage AI technology.

And then there are “transformational” businesses, which account for around 30-40% of companies. These could see a lot of upside from using AI to serve their customer better or more cheaply. On the other hand, they face the problem of new competitors because gen AI lowers the barriers to entry.

The last category is companies concerned with “augmentation.” These are businesses where gen AI could be used to improve efficiency or customer experience. At the same time, these companies will also need to be able to adopt gen AI to remain competitive over time as more companies come under the “transformational” category.

Often the line between the disruptor and the disruptee isn’t clear. Even companies that can bring significant improvements in their operations and products with gen AI could also see the technology undermining their business model.

Take the example of a SaaS company selling software to legal firms on a per-seat basis. This company could lose revenue over time because AI disintermediation means there will be fewer associates or fewer paralegals to use their product.

AlixPartners’ Singh emphasized the difficulty of predicting what kind of future impact gen AI will have on a portfolio, and indeed it’s hard to overstate how fast change is happening.

“I think this a rather important point for private equity, which thinks in terms of years,” Singh said. “If you don’t, at a minimum, have somebody taking the pulse literally every other week, you might miss out.”

This is why many new investments are primarily being made with gen AI in mind.

Bain, for example, relies in part on the same framework that it uses to assess existing portfolio companies when performing due diligence.

The firm even goes a step further by using gen AI to test how vulnerable a company is to disruption. Lichtenstein said Bain builds AI bots to try and replicate the work that a target company does—to see in practice how easily it can be improved, or even displaced, by gen AI.

“It’s very exciting,” he said, “because it shows some tasks can be augmented significantly. Or sometimes it shows that gen AI is bad at the task. But we are doing more building (of bots) during due diligence to test a theory versus just pontificating about it.”

Featured image by Jenna O’Malley/PitchBook News

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  • andrew-woodman.jpg
    Andrew Woodman is PitchBook’s London Bureau Chief and oversees news coverage of Europe and the Middle East. Andrew has been reporting on the private markets since 2012. He was previously an editor with Private Equity International and with the Asian Venture Capital Journal. A Japanese speaker, he spent the best part of a decade in Asia, living and working in both Japan and Hong Kong.
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