Analyzing the Impact of Ritzer's Rationalization on the Work Behind Private Equity
Soci57H - The University of North Carolina at Chapel Hill - Professor Howard Alrich
What is Rationalization
According to American Sociologist George Ritzer, rationalization is the process of making a system more efficient, calculable, predictable, and controlled. Efficiency is seeking the quickest method for completing a product or service as quickly as possible. Predictability ensures that the aspects of products and services are conducted as expected. Calculability is an emphasis on the quantitative aspects of services offered and products sold. And lastly, control assures the conformity of producers and consumers through involvement in the process of creating products and using them. (Ritzer 1 - 4).
What is Private Equity
Private equity firms invest in private companies, aiming to buy, improve, and then resell them for a profit. They raise money from wealthy individuals and institutions to fund these acquisitions. Teams at private equity firms decide which companies to invest in using this pooled capital (CFA Institute, no date). A private equity associate's day starts with news and emails, followed by analyzing potential deals from investment banks. They assess financials, discuss promising opportunities with superiors, and track existing investments' performance. Work hours vary, with busy periods reaching 60-70 hours. Live deals demand constant availability, while slower times allow for networking and planning (Hinckley, 2023).
The Past of Private Equity
The post-WWII era, particularly the 1950s and 1960s, saw the rise of private equity (Bloom, no date). Wealthy individuals sought alternative investments outside the volatile stock market, leading to the creation of private equity funds. This new approach offered companies capital and investors potentially high returns, fostering initial public support (Dowd, 2016). However, the industry was dominated by white males, reflecting the broader financial sector at the time (McKinsey, 2023). A lack of diversity perpetuated through a concept called "homophily," where firms recruited and focused on demographics similar to theri own. They prioritized white men for both entry-level and senior positions (Cassel, Lerner, and Yimfor, 2022)
By 2022, the number of private equity firms had exploded, leading to fierce competition and high valuations (Zhang, 2023). Older firms needed to adapt. They grew in size and market activity, focusing on industries with strong growth and attractive business models. This competitive push led to a prioritization of the biggest and most promising deals.
Efficiency
Private equity firms traditionally faced a slow and manual due diligence process, requiring analysts to wade through massive amounts of data (Jenkins, 2024). Generative AI is revolutionizing this by taking the reins. It analyzes vast datasets, including company records and financials, at superhuman speed. Powerful AI in dilligence can even unearth hidden risks and opportunities that human reviewers might miss (Lichtenstein et. al, 2024). The benefits are clear: Generative AI accelerates due diligence while simultaneously improving its accuracy and comprehensiveness. For instance, AI can shortlist potential acquisition targets 50-60% faster, freeing up valuable time and resources for private equity firms (Venkataraman, 2024). A shift towards AI tackling lower-level dilligence allows professionals to focus on higher-level tasks and strategic decision-making, transforming due diligence from a time-consuming chore into a powerful tool for informed investment.
However, rapid and more efficient methods of research has detached private equity workers from the discovery procress. They get little exposure to the inner-workings of the business and begin to view companies more as cash flow generators rather than human-run businesses (Leland, 2023).
“AI algorithms can identify potential investment opportunities, prioritizing financial metrics or growth predictions. But the investment process for private equity will always have to consider the more complex human dynamic and the understanding of ethics and morality” - Suzanne Lupton, Director of Co-investment at Maven
Predictability
Private equity recruiting is rigorous and often relies on headhunters. For investment banking analysts, the on-cycle recruiting process for PE associate positions starts very early in their analyst program. Promotions within PE firms are also well-defined, with clear hierarchies and expected timelines (DuFrense, 2018). The progression usually starts from an Associate role, moving up to Senior Associate, Vice President, Principal or Director, and finally to Managing Director or Partner (DeChesare, 2019).
Private Equity career trajectory is a very structed timeline. Positions are held by workers for set amounts of time, such as two or three years (Mergers & Inquisitions, 2019). A structured system, however, can lead to drawbacks. The predictability of the promotion ladder can cause employees to lose interest in their current work and detach from their investments. Since the path is clearly laid out, employees might constantly look towards the next promotion rather than focusing on their current role. Knowing their career trajectory in advance can lead to a lack of motivation and hinder engagement in their current work (Chamorro-Premuzic, 2018).
Calculability
In terms of the evaluation of these investments, private equity workers have begun to use metrics such as Internal Rate of Return (IRR) and Return on Investment (ROI) to judge the success of their investments in calculate methods (CFA Institute, 2020). IRR and ROI are used as shorthand benchmarks to compare the relative attractiveness of diverse investments. Projects with the highest IRRs are considered the most attractive and are given a higher priority due to private equity workers’ focus on calculated metrics and predictable returns (Goedhart, Levy, and Morgan).
By relying on ROI and IRR, private equity evaluations have begun to shift away from qualitative evaluation, focusing primarily on the calculated returns from investments. Private equity workers have reportedly become less sensitive to reallocating funds towards more lucrative opportunities, since investments area viewed as cash flow instead of businesses (PEL, 2024).
“Why am I investing $100 million in my existing portfolio company when I can put that capital into another business which I think is going to provide a much better [return on investment] down the line?” - Michael Handler, a Financial Restructuring Partner at King & Spalding, Handler
Control
Private equity firms bring a variety of experience to the table, pushing companies become more efficient and profitable. The workers often make decisions regarding streamlining operations and improving corporate decision-making. Streamlining and optimization can sometimes involve tough choices like reduced workforces and cost-cutting, but is seen as a necessary step towards long-term profitability.
The push towards more control on portfolio companies often leaves private equity wokrers at a crossroads. While private equity professionals need to continue optimizing and improving their portfolio companies, they need to consider the lives of the people they affect (Kovac, Burns and McLinn, 2018). For example, some private equity firms are looking to revitalizing neighborhoods by investing in populated housing, but it often comes with an increase in rent prices (Vogell, 2022). While short-term adjustments may occur, the ultimate goal is to create a sustainable future for both the company and the surrounding community.
The Future of Private Equity
The future of private equity is looking more analytical and insightful thanks to advancements in AI. Generative AI is streamlining deal processes, while Natural Language Processing (NLP) is poised to revolutionize how firms assess potential investments (Lichtenstein, 2024).. NLP can analyze vast amounts of qualitative data like news articles, reports, and calls, providing a richer picture beyond just basic metrics (Pahuja, 2024). Automated, qualitative dilligence can free up private equity workers to focus on the bigger picture, using their expertise alongside AI to make better investment decisions that consider the lives of everyday people (Stichbury, 2020).
The question remains, though. How will private equity workers respond? At the end of the day, automation can only take a process so far. Human workers make the final decision in private equity investments. Especially in such high stakes investing, it will be crucial to see how private equity workers utilize new advancements such as NLPs, and how their sentiments and attitudes change toward their work, career, and future.