Employee Ownership at Scale w/ KKR's Pete Stavros

Previously on Dry Powder, Peter Stavros, global co-head of private equity at KKR, explained how they have built one of the most operationally intense investment models in the industry. The reality is operational improvement and driving operational change is really hard. Today on the show, we'll explore one of the more fascinating extensions of KKR's value creation playbook, a broad-based employee ownership program that has now reached 85 companies and 200,000 frontline workers.

Just think of the benefit of not having workers stream out the door every year. You know, what that means for customer satisfaction, quality, productivity. Think of how unproductive people are in the six months before they quit. I'll ask Pete how this program got off the ground, what lessons he learned the hard way, and why it can be such a powerful performance lover when done right.

This is a free benefit, and the company gets paid back on culture. We'll also discuss where AI is actually delivering value across KKR's portfolio, the growing role of private wealth capital, the patience required to win in overseas markets, and what Pete believes will ultimately define the winning private equity platforms of the next decade. I'm Hugh MacArthur, Chairman of Bain's Global Private Equity Practice, and this is Dry Powder. Now, Pete, one of the newer extensions or an extension of your model that I've heard about is broad-based employee ownership.

What does that look like at KKR? How did that emerge from your broader approach to value creation? And then tell us what changes inside of a company that you own when the entire workforce becomes owners. So we started this 15 years ago.

I was running the industrial group at the time. I started with one business, a company called Capital Safety. The company made fall protection equipment. So if you've seen workers up on a building being built or a bridge or a wind tower, they wear a vest and then they wear a harness that connects the vest to the structure.

So that protects them from falls. Sure. We had not been super active in industrials at the time, had not invested in lots of businesses with large frontline, so-called blue collar workforces. And we were frankly surprised at the state of the workforce.

There was a lot of discontent. There was a safety issue. It was a great business and the people cared about one another, but rapid growth can often cause you to take your eye off the ball. So God forbid there was a loose stitch in one of these harnesses.

It could be someone's life. So we got all over it. We brought in a bunch of new leadership to not only improve safety, but wanted to get people more engaged and less likely to quit. And one of the things we tried was ownership.

We did it horribly. We communicated it in a way that no one understood it. We didn't even tell that many people about it because we were worried about over-promising and under-delivering. We didn't tie ownership to a bigger ethos.

So it was just like there was some value set aside for workers. We did not, for example, teach them about the business, share the key operational levers we were pursuing and how they could contribute. We didn't teach financial literacy. We really didn't change anything other than setting aside upside for workers.

So that was how it started. And as poorly as we did it, we felt like we were onto something, you know, once we saw the exit and how meaningful it was to the workforce. And we did make progress in safety and engagement. I can't credit a whole lot of that to the ownership program, but we said, well, what if we could do both of these things, like get the ownership program in place and drive some of these cultural initiatives?

what might be possible. So that was the beginning of it. We've now done this with 85 companies, about 200,000 frontline workers have ownership in these programs across those 85 companies. We think they are in a position to make $14 billion of wealth for themselves.

So the numbers are massive in terms of worker wealth. The workers don't pay for this. I should note, this is a free benefit and the company gets paid back so to speak on culture So we looking at engagement scores and quit rates That what we focused on And when it works and I acknowledge it doesn always work This isn't magic. It's not like you put some ownership out there and workers are suddenly thrilled.

When it works and the leadership team does put all the effort in over years to shift the culture, you can get that Ingersoll-Rand type payoff where you're hiring thousands of fewer people. I mean, just think of the benefit of not having workers stream out the door every year. You know, what that means for customer satisfaction, quality, productivity. Think of how unproductive people are in the six months before they quit.

You know, so you're just doing wonders, not only for the culture, but for the performance of the business. And that's what we're after, you know, is we want to create wealth for workers. We think it's the right thing to do. and it also, when done well, can really inflect the performance of a company.

Totally believe it. No system is perfect, but it sounds like a big step in the right direction and you learn more about getting it right, I'm sure, every time you do it. You get a little smarter every time, yep. Now, Pete, the way this podcast works, if I don't say the term AI at some point and have a guest respond to it, it will not be released by the company and nobody will listen to it.

That's what we've learned about over time. I haven't said AI yet, so I'm gonna say it now. How does AI factor into KKR's model of finding these under-managed companies and really being able to focus on operational excellence and execution? So what we started years ago was running what I would call AI experiments in the portfolio.

So we're the largest private equity player in the world. We've got more portfolio companies than anybody. So we've got now approaching 250 companies around the world. So we should be able to learn faster than anyone.

So what we're trying to do is at each company, do an AI diagnostic. So bring in an outsider to do that. Because if you ask a sitting management team, what are the risks and opportunities with AI? Yeah, this is all so new and changing so fast, they don't know.

So we bring in an outsider to do an AI diagnostic. We ask each of our companies to then run at least one experiment. So think about what we're doing as a huge grid. You've got the companies along one axis and then potential AI applications across the other.

We're running all these tests with different vendors. So we're testing dozens of different vendors. And when we get that match of application vendor and maybe even industry, depending on if it's an industry-specific AI application, we'll roll it out across the portfolio. so that's at the highest level what we're trying to do we're also trying to embed ai into our firm we want more ai engineers and experts sitting with our investment teams we want our companies hiring ai engineers directly into the business not just relying on outside vendors and we're just learning um you know what i could tell you from our experience is it's helpful but it is still a long way from transformational.

So it's another value creation lever, but we have not seen many, if any, instances of what you sometimes hear in the press of like, my God, there's like these massive AI transformations going on. There's some, but it's still early. And across our many, many, many experiments, it tends to be an incremental lever, not the driver of a deal outcome. Totally agree.

so far and don't get me started about what goes on in the media and what they're claiming out there. But I like the way you phrased it. It's helpful, but not quite as transformational as everybody is sort of thinking about just yet. We'll see what the future happens to hold.

I'd be remiss if I didn't also ask you about your thoughts on private wealth. KKR has been one of the industry leaders in expanding into private wealth. And I'd love to get your thinking, Pete, on how that shapes the way you both structure investments and think about things like timing or co-invest or anything else that might come to mind? How does it change the way you think about running the business?

It has almost no impact on how we run the business The one place it does have an impact is it gives us more certainty over funding So if we doing a deal that requires billion of equity and we want a billion and a quarter in the fund, we can have certainty for some of that incremental capital. We still give a significant amount of co-invest to non-clients of the firm. So we still are short of capital, even when you include all of our clients and all of our co-invest, We're still calling hedge funds sometimes because we can't place the money.

So we're really displacing some of that non-client capital for the most part with our Evergreen vehicle. So our Evergreen vehicle is a pure co-invest vehicle. It comes alongside every single private equity transaction we do. If we do 40 PE deals around the world in a given year, a slice of all 40 goes into the Evergreen vehicle.

That's really important to us because we want alignment. We don't ever want either the Evergreen vehicle or our LPs to say, hey, wait a minute. Why is this deal over here and not over there? We think that's a dangerous way to create conflicts.

So we're totally aligned. It's a pure co-invest. It takes a slice of everything that we do. And the only real impact is it gives us a little bit of incremental deal certainty.

I think you know, and your audience will know, the logic of the Evergreen vehicles is it's hard to access the private markets. There's a lot of different data points out there. The one I hear most consistently is 90% of companies with more than $100 million in revenue are private. When you look at the number of public companies in places like the U.

S. and the U.K., they're down by half over the last 20, 25 years.

So the private markets people want access to hasn't been easy unless you're really wealthy. or you work for a public union that has a pension plan that invests in alternatives. And so the idea was giving a broader slice of the population access to the private markets. Sure.

Diversification. Pete, you've mentioned Asia a couple of times during our conversation. And I know that you've got a personal interest and you've been investing a lot in Japan. And Japan is the ultimate Asian market, at least in my experience professionally, where patience is the word that you've needed to have over the last 20 years or so for that market to open up and really take shape.

What gave you the conviction to invest there early and stick with it and stay consistent, even when it didn't look like the market was going to open and be friendly to private equity investors anytime soon? Yeah, well, all the credit has to go to Henry and George and then Joe Bay who went out and built it. We were there for years before we even did a single deal. You know, it's a very difficult market to break into.

You don't just, even if you hire a local team, you don't just show up and start doing things. So there were, and again, I can take no credit for this years and years and years of spade work, you know, visiting government officials, industry leaders, and trying to convince people that we would be supportive capital partners and be helpful, you know, towards some of the government's objectives. I mean, as your listeners will probably know, Japan is in the middle or early stages, I should say, of this economic renaissance where they are asking companies for greater capital discipline.

Let's divest of non-core subsidiaries. Let's not sit on excess cash. The FSA and the Tokyo Stock Exchange, they're pushing for more transparency, more financial information printed in English so more people can consume it, independent boards of directors, special committees, lots of things that it's a little bit like what the United States went through, you know, 50 years ago. And so there's a tremendous number of carve out opportunities, take privates.

And so I think, you know, where did the conviction come from? I can only speak on behalf of the folks who did the work. I think they just saw a very long-term opportunity. They didn't know when it would happen, but they just said at some point, the same thing with Korea, If you look at what's going on with Korea right now, they are in the early stages of copying the playbook from Japan.

They've got huge conglomerates with non-core subsidiaries. They want to open up their capital markets They want more Western capitalism And that going to open up just a huge amount of opportunity for people who are well So I think that was the conviction that Henry and George and Joe and Scott had, which was, don't know when, but long-term this is going to work. And I'll just say one other thing, which is, it's one of the most fun things about working at KKR is people don't care about next year or the year after.

They're really thinking 10 years out, 20 years out. I often say we're trying to build a firm that is forever. We're not trying to build something to sell it. We want KKR to be around way beyond when all of us leave.

And that, it creates a different mindset. When people say, oh my God, you guys are gonna go sink how much money into Japan for the next 10 years before you get anywhere? People don't care. As long as decades out, the opportunity's there, they're happy to do it.

And it's also why when I talk about all the resources we're blessed to have and all the colleagues in Macro and Capstone and our geopolitical team and we got a huge fundraising team and our capital markets team, the firm's happy to invest. It just makes this job so much easier and so much more fun. Well, it's really interesting, Pete, just hearing you sum up like that, because the two words that were playing around in my head, as I want to mention this last question to you, are when I'm thinking about this conversation, I'm thinking about innovation, and I'm thinking about patience.

Those two words keep popping into my head that you've done tremendous things as an industry leader that lots of people haven't done before in private markets and in private equity, of course, in particular. But you've also had the patience to see things through when you believe the model. And not everything goes well the first time you try it. But if you have the patience and the endurance and you're an innovator, that seems to have worked tremendously well for KKR as a business model and private equity over the years.

And so the last thing I wanted to ask you was, taking all of that and your other thoughts and your other experience, if you look ahead five or 10 years out, what do you think is going to define a winning private equity platform for KKR? I think the way we're going to define winning, of course, it's going to be returns. We're going to have to stay at the top of our industry and the top of our game, but it's going to have this broader definition around how are we leaving these businesses?

And we're going to make mistakes. Not everything, of course, that we do is going to be perfect and work out according to plan. But on the whole, what we really want are investors who really care about how we're doing what we're doing. So we want those operationally inclined folks that I referred to, who they're deep enough inside of a company that they'll come to their partner or to Nate and me and say, hey, this company that we just bought, I didn't understand this, but they've got non-competes for low-wage workers.

That feels wrong. We should strip these out. Or this company we just bought didn't fully understand this, but there's a ton of contract workers, and it feels like just a way to save a little bit of money on benefits. We don't want that.

Or this company has a pretty extensive use of seasonal workers, again, to save a little bit of money on benefits, and we don't want to do that. So we're trying to find those folks who love operations, want to be deeply involved, and want to do things in a way that's going to make us all proud. So of course, again, we got to deliver. Our investors are often teachers' retirement funds or police officer retirement funds.

So there's no room for doing anything that's going to be concessionary from a return perspective, but you can do both. You know, you can deliver great outcomes for investors and do good things for workers and for the company too. Sounds good to me. Pete, thanks very much for a terrific conversation and for stopping by Dry Powder today.

I'm sure our audience got a tremendous amount out of it. I know I did. Thanks again. Thank you.

I'm Hugh MacArthur. Thank you for listening.